Is the Treasury Driving the Dollar's Fall?

The factors driving the dollar seem to vary with the season. Last fall at the height of the financial crisis safe haven flows trumped all considerations; at one point investors accepted zero return for the security of holding US debt. The dollar rose 17% against the euro in a month and made similar gains versus the pound Sterling, the Canadian dollar, the Swiss franc and the Australian and New Zealand dollars. But even at maximum market panic dollar superiority was not total; the imploding Yen carry trade drove the dollar down against the Yen to 90 to the dollar despite the huge inward flows to US securities.

The dollar’s virtues last fall were very specific; in a catastrophe everyone’s first choice for safety was American debt. The dollar’s competitive value was not the point, only its supposed security mattered. But those conditions could not last, and as the financial crisis became an economic crisis and the threat of financial system collapse waned the fear of wholesale loss of investment principal ebbed. In moderating circumstances the funds that had been stashed in the States for safety (and little or no return) began to be withdrawn seeking other more productive currencies and investments.

The degree of panic into the dollar last fall guaranteed a correction out of the dollar; but until the recent move that began on May 20th, the euro had stayed below the 38% Fibonacci retracement level of the July to October 2008 collapse.

The euro-US dollar equilibrium held from mid March until mid May with the pair largely confined to the range of 1.3100 and 1.3600. The original burst through that range on March 18th and 19th was prompted by the Federal Reserve announcement that it would buy Treasury Notes in an effort to keep consumer and mortgage interest rates low; this was the so called ‘quantitative easing’ policy. The Federal Reserve Board knew that the amount of US debt scheduled for sale to the credit markets in the months ahead could undermine its low rate policy.

Mortgage rates are not set by Fed fiat but take direction from the credit markets and one of the important market benchmarks are US Treasury rates. The initial market reaction to the Fed quantitative policy was extremely negative for the dollar with the euro gaining seven hundred points in two days. But despite the Fed announcement traders seemed to forget, the market absorbed that news and the dollar regained all that it had lost after March 18th.

Enter the budget of the new American administration and its blueprint for the US economy. Treasury rates at the long end of the yield curve have been rising since March. The ten year note has gained 1.5% in yield in that time. The bond market clearly anticipated the impact of the government’s financing plans well before the actual auctions began. But the turmoil in the bond market did not dramatically affect the currency markets until last week.

In a classic economic comparison higher interest rates are one of the prime drivers of a currency’s worth. US rates are clearly headed higher, though not at the Federal Reserve level, but the dollar has moved from strength to weakness. Gone is the dollar support from the expectation that the US economy, under the spur of historically low rates and massive fiscal stimulus, will be the first industrial economy to leave the recession. Gone is the credit to the Fed’s early acknowledgment of the financial crisis and actions to mitigate the recession.

The correction out of dollar assets will run its course. But the currency market focus on the amount of Fed quantitative easing, on the US deficit and future inflation, will remain. There is little confidence that a government as indebted as Washington will be able to withdraw the liquidity flooding the US financial system. The may even be the suspicion that Washington will realize that monetizing the debt is probably the only politically realistic course to alleviate the debt burden

The same proactive Fed and government policies that only a few months ago were seen as strongly supportive of the US economy and the US dollar are now the dollar's nemesis. Is the Treasury is the new driving force behind the dollar’s fall?

Comments

[dcb:]

On a number of posts I have detailed my thought that the treasury and fed are in fact our own worst enemy. Anyone who think they can pull this off is just as foolish as those who thought that keeping interest rates down during the greenspan era would be without consequence.
1) the easiest way for the fed to fix the banking issue is to inflate our way out of it. they will talk up the dollar as always, but their actions are always toothless
2) there will be huge pressures on the political end no to withdraw support too early. This will also come from bankers. Notice how they love to state there will be dire consequences to not giving them something. then when you don't they short and blackmail the govt
3) having thought very deeply about the inflation/deflation issue I am convinced fears of deflation are very overblown. they should in fact be part of the normal business cycle. Yet the Fed fears this worse than death. periods of deflation remove the excess of credit bubbles. when we do not allow them we have huge credit busts
4)despite statements to the contrary. We will force leverage intot eh system. banks won't be loaning l money, but they will be using cheap credit to buy assets. this will distort supply demand equations
5. ) therefore, the net effect should be inflation, credit tightening, bust again. dollar gets killed either way.

Jun 03 06:20 AM

[User 353732:]

The Treasury and the Fed, aided by Congress and its camp followers and abetted by Wall Street are driving America's fall as an economic and financial hyperpower. It is this fall that, in turn, is driving the dollar's fall. An economically weak nation cannot have a strong currency. As the economy is wilfully debased , so the currency is degraded. As global confidence in our economy and serial financial engineering wanes, so investor confidence in the dollar wanes.
6 months ago global investors thought the dollar was a safe haven because they had no concept of how economically incompetent and financially fraudulent our decision making elites really have become. Now they know; they are becoming aghast; the dollar reflects this new and distasteful awareness. The world is voting against the dollar because that is the only way it can vote against our governing elites.
What American citizens are not ready or able to do, global investors are prepared and willing to do.

Jun 03 06:47 AM

[Clive Corcoran:]

The Fed will probably be a spectator for most of what happens from here onwards in regard to long term rates and the dollar

Jun 03 07:57 AM

[EUARTE:]

Why is this always the question? The United States has been debasing it's currency for decades. Obama now will knock out the dollar almost completely. Obama thinks Weimar is a German restaurant.

Jun 03 02:54 PM

[carey_jim:]

It isn't wise to blame one political entity for the economic mess we are in. The causes are complicated and the blame can be spread over the entire population.

We are, at least nominally, a democracy. We voted for these people and for this system.

We can vote for new people and even change the system using the constitutional tools we have. Why don't we ever do it?

Jun 03 03:01 PM

[Market Folly:]

definitely agree that the focus will remain on inflation. However, this could take much longer to fully come to fruition than people realize (years). It's still hard to ignore though. Julian Robertson of Tiger Management (legendary hedge fund manager) has already braced for the inflationary supercycle by investing in steepener swaps, which is basically the same as shorting US treasuries: www.marketfolly.com/20...

Jun 03 03:21 PM

[RTF 360:]

The bankruptcy & nationalization of banks and automakers was a 'trade' set up by fed Chairman Alan Greenspan for personal profit through Paulson & Co because in his eyes there are only two kinds of people , the 'takers' and the 'taken'.

The ongoing crime against the American people using Over the Counter (opaque ) derivatives has been cleverly disguised by Goldman Sachs, et al who uses the International Commodities Exchange as a front and 'plausible deniability' that OTC derivatives are 'regulated' when in fact the opposite is true.

www.reuters.com/articl...

The Federal Reserve is evil ; Ron Paul's bill to audit the Federal Reserve (HR 1207) now has 179 co-sponsors

Jun 03 03:47 PM

[Living4Divi...:]

Great article! You could say that the Treasury is promoting the dollar's fall, by monetizing the debt. Certainly a weak dollar would beneficial to the US economy,

But you could also say that China is helping the Dollar fall. China has slowed down on their net purchases of Treasuries. Instead of buying NEW Treasuries, China has been exchanging one dollar-denominated asset for another — selling the debt of government-sponsored enterprises like Fannie Mae and Freddie Mac in a hurry to buy Treasuries. Beijing is concerned that inflation will erode the dollar’s value in the long run as America amasses record debt.

Rather than buy Treasuries, China is seeking to change the ways that it sterilizes the surplus of dollars that it receives from the U.S. Instead of the Chinese government buying up excess dollars, and investing them in U.S. Treasuries and the bonds of GSEs, China is
a) encouraging private Chinese companies to use dollars to make investments (thus recycling the dollars) and...b) Using the dollars to stockpile commodities, such as iron ore, crude oil and grain.

The bottom line to all of this is that China is rightly worried about inflation in the U.S. and the impact that inflation would have on China's holdings of long-term U.S. bonds. While China still seems committed to the dollar peg, China is diversifying its foreign exchange reserves by using it's surplus dollars to purchase real assets that are inflation resistant such as commodities and capital investments.

So who is weakening the dollar? The US Treasury started the party to devalue the dollar, and now the rest of the world is joining in.

Jun 03 09:17 PM

[Living4Divi...:]

DCB - I agree with your post.


On Jun 03 06:20 AM dcb wrote:

> On a number of posts I have detailed my thought that the treasury
> and fed are in fact our own worst enemy. Anyone who think they can
> pull this off is just as foolish as those who thought that keeping
> interest rates down during the greenspan era would be without consequence.
>
> 1) the easiest way for the fed to fix the banking issue is to inflate
> our way out of it. they will talk up the dollar as always, but their
> actions are always toothless
> 2) there will be huge pressures on the political end no to withdraw
> support too early. This will also come from bankers. Notice how they
> love to state there will be dire consequences to not giving them
> something. then when you don't they short and blackmail the govt
>
> 3) having thought very deeply about the inflation/deflation issue
> I am convinced fears of deflation are very overblown. they should
> in fact be part of the normal business cycle. Yet the Fed fears this
> worse than death. periods of deflation remove the excess of credit
> bubbles. when we do not allow them we have huge credit busts
> 4)despite statements to the contrary. We will force leverage intot
> eh system. banks won't be loaning l money, but they will be using
> cheap credit to buy assets. this will distort supply demand equations
>
> 5. ) therefore, the net effect should be inflation, credit tightening,
> bust again. dollar gets killed either way.

Jun 03 09:18 PM

[swaps:]

An uncomfirmed e-mail from another source - and the mainstream media will never confirm this - lists the trashing of the U. S. dollar as part of the 2009 Bilderberg meeting agenda. This meeting in Greece was attended by Geithner, Larry Summers and a few U. S. generals as well as Bill Clinton and the past chairman of Chase Manhattan Bank who shall remain nameless.

Jun 03 11:00 PM