The Weak Dollar Crowd Is Too Confident

A warning to all you exposed to the dollar carry trade, either directly or indirectly. A group which includes:

• Anyone borrowing in USD to buy short-term assets in another currency.
• Anyone borrowing short-term in USD to buy long-term USD assets, i.e., every U.S. bank.
• Any U.S.-based company selling their product to non-USD consumers.
• Anyone invested in a U.S. company who is borrowing short-term in USD and buying long-term assets and/or selling products in non-USD currencies. That is, anyone long U.S. stocks or U.S. corporate bonds.
• Any U.S.-based investor long any non-USD asset, i.e. any investor in foreign stocks or bonds.

So basically anyone holding anything other than cash.

Below is the intra-day chart on USD/EUR from this past Monday:

What the hell happened at noon? Bernanke made a passing reference to the dollar. That's it. Here's the whole quote:

The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.

Now really, there is absolutely nothing there that suggests the Fed is going to do anything about the weak dollar. In fact, all he's doing is justifying the recent decline in the dollar. You can think what you want about why the dollar is weak or even whether it's desirable or not. Bernanke doesn't care about the dollar.

And yet with this tiny nod to doing something about the dollar, the euro plummets. Just think about what's going to happen when the Fed actually hikes rates. There are so many dollar shorts out there. We will be looking at the mother of all short covering rallies. And the carry trade crowd is going to get absolutely crushed.

Will this happen this month? This quarter? This year? I don't know. How impactful will this event be on financial markets? I think it will be quite large, although whether that means S&P -10% or -20% or -30%, I'm not sure. I'm also not sure that we don't rise 10% between then and now and only correct back to where we are. I actually think 2-5 year bonds, including Treasuries, are the most exposed U.S. assets, not stocks, but we'll see.

Either way, I'd love to see the Fed make some kind of move, even if it's hiking from 0% to 0.5%, to stem the tide of constant USD selling. The dollar weak crowd is too confident, and all that confidence is what causes bubbles. Alas, I don't think it's going to happen.

Comments

[woollyB]

I agree, for those of us who are staying safe, the forthcoming dollar rally is going to be fun to watch.

2009 Nov 19 12:27 PM

[Wilson Siu]

If the Fed hikes the interest rate:

-confidence in housing will be shaken as people will not be sure about the direct going forward.

- interest payment on both persoanl and national debt will go up.

- economic growth will be slowed and unemployment rate will rise further.

Wishing someone to do something and someone actually being able to do that are two different animal species from two different planet.

If all children in the world would not visit any internet games or Play stations, and focus only in academics, their GPA will go up significantly. ( will they?)

If I shall wake up everyday in the morning, and work out two hours in the gym, while skipping every weekdnend's beer drinking, I will be ripped like Rocky Balboa or Bruce Lee. (but I miss out the party with friends, and social life, so will I?)

To be more clear, if I work during the day time, skip sleeping, and work a second job at night, my income would increase by a substantial percentage. But is this possible and if possible how long will it last? I will be so tired during my day job that I will be fired very soon, and sure I can work on my lower paying night job all the time!

Thus if the economy and unemployment rate and both personal and nation debt level does not fit nor tolerate an increase in interest rate, why mention the possibility of all the kids stop touching any playstation and focus only in academics or the dim possibility of me skipping weekend drinking and only visit the gym to stay lean like Rocky in his prime or like Bruce Lee!

Btw, what species of animal is that from which planet?

2009 Nov 19 01:13 PM

[Wilson Siu]

Pls notify us and remind us about not being too bearish in USD when the economy is really growing again and when the unemployment rate drops back to at least 8%, with underemployment rate also dropping back down to at least 5-6%.

2009 Nov 19 01:23 PM

[MikeyMouthsOff]

The dollar will remain weak for some time to come. Chairman Bernanke is well versed in the economic history of the Great Depression and is loath to repeat the mistake of tightening credit
too early in the recovery. That is, if you believe the economy is actually getting better. I don't. Watch the employment reports. By the end of February the jobless rate will reach 11%. Why? Because a mediocre retail holiday season will force businesses to further reduce staff (and not just the temporary help they hired for
November-December.) Non-retail companies are already announcing plans to fire workers before year's end and into the Spring.
One of the Fed's stated missions is achieving full employment. Raising interest rates to strengthen the dollar will have a huge negative downside with respect to that goal and won't / can't happen for some time to come.


On Nov 19 12:27 PM woollyB wrote:

> I agree, for those of us who are staying safe, the forthcoming dollar
> rally is going to be fun to watch.

2009 Nov 19 01:30 PM

[Bruce Vanderveen]

A real dilemma here. When, if ever, will we have an economy well enough to raise rates without crashing markets. We may get out of this okay if the economy really improves. if not ... a crash of some kind is inevitable.

The noon spike shows just how jittery things now are.

2009 Nov 19 01:37 PM

[Mark Anthony]

That's absurd. Basic math says there is always MORE dollars lended than dollars borrowed. The difference between the two is the money lended to Uncle Sam, in the form of US treasury holdings.

So, the ones borrowing the US dollar to invest in commodities or non-dollar assets, are ALWAYS in the minority. There might be $1 trillion worth of dollars borrowed in the US dollar carry trade, probably way much less. But there are at least $13 trillion US dollar cash lended out by investors, mostly to the US government, in the form of $12T worth of US treasuries.

These bonds or debts holders are absolutely in the majority and they are in utter danger of losing everything, while the US dollar carry traders, who are in the absolutely minority, stands to profit from the collapse of the dollar.

2009 Nov 19 02:41 PM

[phdinsuntanning]

certain folk visited Tokyo,
Mr. Yen said him Im broke,
then the guy jumped to China,
and they told him: credit nope.

So he called is barbed printer,
better old on on the dope.
Party is over for some timing,
till our owners give us hope.

Short those bars and balck refined,
tell our gold men there is no hope.

Certain folk you got the tough job,
just when party came to stop.
I dont envy your position but you
still have some good hope:
balance budgets and bring soldiers
to the peace of moms and pops.

2009 Nov 19 02:56 PM

[pungent]

Wow! A drop from 1.498 to 1.488; i.e. a drop of 0.01 euro. Are we sure this wasn't just a wrong keypress somewhere? Anyway, this is why I stay out of currency trading -- drops like this are not for the faint-hearted.

2009 Nov 19 05:02 PM

[Moon Kil Woong]

My bet is the Fed won't allow a massive dollar slide at the beginning of the new year. They probably means draining a little out of the QE quagmire giggly giggle (see Family Guy). If that happens dollar shorters will have to rethink their plans even if it is only temporary.

I do hope long term the US government gets fiscally prudent and doesn't past another round of stimulus and the Fed does attempt to normalize interest rates and quash the abnormal liquidity in the market. However, I think this is but a dream.

In the end the Federal Reserve is like a politician. It likes dispensing apparently free money to it's constituents (the banks) at the cost to the rest of Americans. That is how it derives its power. To assume it will opt to weaken its power is like asking the Federal government to pass a balanced budget. It may only happen once in a lifetime. And we know we already saw that when Volker was in power.

2009 Nov 20 12:37 AM

[Dopamine]

Trade WAR.
What does the US want....trade war. with China because of the cheap Yuan...The US wants to win a sales war, ...sell products...sell USA products....Jobs are the key to the recovery.....
So the dollar must stay low.....
The Obamanomics team say Its Jobs Stupid...

Look at the CHF....they keep going lower....they must keep the CHF low as they must be able to sell their goods to the EU.....
The CHF does not want to be overtaken by the safe haven status...

The USD dollar will stay low for the next......year ...

2009 Nov 20 12:43 AM

[Cliff Wachtel CPA]

Good article- a few points to consider

Fed has no interest in a strong USD as long as the economy and employment are weak,AND inflation stays low.

FX traders realize this and thus continue to sell the USD, largely for carry trades (ie sell low interest USD buy higher interest AUD or EUR).

Thus the USD's only near term hope for a rally is a stock pullback, which raises the fear level and causes these carry trades to unwind and sparks USD purchases (a simplified explanation, I know)

Stock pullback should come at SOME point as part of a normal test of support, never mind the irrational nature of much of this unjustified rally.

However, timing the markets is tough, so don't start going long USD and shorting risk assets UNTIL you see confirmation of an S&P 500 pullback. See my daily instablogs and weekly outlook instablogs (on Sundays) for alerts on this and overview of global asset markets.

2009 Nov 20 01:09 AM

[matth]

In the short term go long anything foreign and commodities. I'm currently heavy in EM in general and Brazil in particular, Gold and commodities in general, World Bond and EMD. Sometimes next year I'll switch around and dump a lot into positions such as UUP and TBT/TYO/etc. I doubt the Fed raises rates until two key things happen. Firstly the economy actually turns around. And secondly after the elections next year. If you hold for too long you will get crushed once the Fed switches policy and the dollar rebound. However there is still plenty of time to ride the wave.

2009 Nov 20 10:42 AM

[chessexpert]

When the President and Congress reduce socialism (regulation, taxes, redistribution), the real economy will improve. Until then, you may do better looking oversees for investment opportunities.

2009 Nov 20 11:58 AM

[HerrHansa]

federalreserve.gov/new...

They could strengthen the US Dollar by further shortening this, perhaps even returning to a true "overnight" model.

2009 Nov 20 12:28 PM

[thkalinke]

I'm not sure we need to see any Fed tightening to have a painful bounce in the buck. All we need is for our economy to poop out. Say, a much worse than expected 2009 holiday retail season, or a rash of defaults in 2010 so bad that it once again wipes out equity at banks. The Fed doesn't have any more room for lowering interest rates, and that may translate into de facto tightening if our economy weakens.

2009 Nov 20 03:11 PM

[Tekatl]

Fed tightening would be painful at this point as MikeyMouthsOff stated earlier and yes Bernanke knows this as a student of the Great Depression. The only way we will see a dollar rally is Interest Rate Increase or Chinese Yuan/Renminbi peg correction. And yes, the currency markets are much more volatile than the stock market and there is higher leveraging, but that's the fun of it all. China is China and they will do a peg correction whenever they feel, so expect the dollar to remain weak or hit a lower low in 2010 and quite possibly in 2011. Hence, global reserve banks and commodity countries looking at alternatives to the US Dollar for reserve and currency pegs.

2009 Nov 20 06:55 PM

[INFOCUS]

IF THE DOLLAR WILL REMAIN WEAK FOR A LONG TIME??? PEOPLE DOES NOT NEED A JOB.(WHAT IS YOUR JOB?I'M A CARRY TRADER,WHAT DO YOU DO? I DRINK BEER ALL DAY AND INVEST MONEY IN BRAZIL, CHINA, ASIAN.I BORROW MONEY IN THE US)I SELL LOW INTEREST THE USD, BUY HIGHER INTEREST OVERSEES.WHAT LIFE.THIS IS A JOKE.

2009 Nov 20 07:22 PM

[dragonpaw]

Good god; if the above comment is for real, the bottom-feeders are having a hey-day.
Note: real investors and traders; "all bet are off (as in -kilter)".

2009 Nov 20 08:59 PM

[crazyv]

maybe I am a nit picker- but I think the author would have more credibility if he realized that they are 2-5 bonds but rather 2-5 year notes.

2009 Nov 20 10:07 PM

[Formyx]

The Fed has no desire or reason to raise rates.

Fed's policy is based on the premise that a return to growth will happen with a controlled decline of the currency.

Unfortunately, things never happen as planned in the real world and the market may force its hand. As it is usually the case, this will happen in a time of weakness.

2009 Nov 21 06:32 PM