Is the Dollar Rallying on Realigned Expectations?

The recovery in the US dollar and in equities has been very impressive. In Monday’s Daily Fundamentals, I said that “despite today’s move, the dollar’s rally may not be over.” Gold continues to provide a strong indication of the market’s risk appetite and dollar sentiment. If you want to figure out if investors are really nervous, just take a look at gold. Tuesday, gold prices have fallen by another $10 to $919.00 an ounce. This suggests that the dollar’s rally is set to continue. There could and will probably be retrenchments, but the overall trend of the dollar is up.

As previously indicated by the bounce in the University of Michigan consumer confidence numbers, sentiment in the US has improved according to the Conference Board’s survey. Although jobs are increasingly “hard to get,” consumers are starting to accept the current state of the US economy as the way of life. This does not mean that the troubles are behind us because house prices fell by the largest amount on record in May. Going forward, the stability of the US economy will depend on oil prices staying low.

Crude is trading at approximately $121 a barrel and as long as it remains at current levels or falls further, inflation and inflation expectations will ease. Not only will this loosen the noose for central banks around the world, but it will also provide respite for consumers and businesses. In turn, this will add further fuel to the dollar which I expect to break 1.55 against the Euro and at least 109 against the Japanese Yen.

However keep in mind that even if the dollar is rallying, it does not necessarily mean that the US economy is stabilizing. The announcement that Merrill Lynch (MER) is looking to raise capital by selling new shares and selling their debt at a fifth of their value is not completely good news because it indicates that they are desperate for cash.

Therefore the dollar’s move represents a realignment of expectations. The weakness of the US economy has already been priced into the market, but the deterioration in places like the Eurozone, New Zealand and the UK is catching many traders by surprise, triggering weakness for the Euro, New Zealand dollar and British pound (See 3 Currencies to Short).

Looking ahead, the ADP Employment report is due for release Wednesday. The market expects private sector employment to fall by 60k jobs. Although the report is a leading indicator for non-farm payrolls, traders need to be careful of relying solely on this report since it can have a shaky track record.

Comments

[contender]

As much as I hate to admit it -- cuz im way against the creative abandon the fed and sec-treas have used to abate this credit/confidence issue -- I think Paulson may have restored some confidence in the bucko. I hear those TV personalities saying the dollar is coming down cuz oil is coming down... errumm... whatever ! If our monetary life is predicated on sentiment to a rectangular piece of paper then methinks our (and their) confidence in our dollar is factor # 1 - I cant reconcile the huge fiscal deficit we are carrying with a strong dollar though

I have to take issue with your conclusion that $120 oil is acceptable - I dont think it is. The current 'shock' has yet to completely seep through to the consumer -- and we have heard quite a few companies talking about using the pricing power they have to jack up prices. Of course they are already engaged in the American past-time of just putting less content in each unit and saving costs on the margin.

In any case I think oil needs to be closer to $100, and /should/ be $85, tops at this point -- I guess Ill settle for $100 -- but $120 is still too high by far.

Take care.

[buyitcheaper]

It's rallying b/c long term rates are going up, significantly, that's killing gold and oil, and that's strengthening the buck. PLUS other countries are acting intelligently and raising rates themselves which perversely it seems to be strengthening the dollar as well. I think we MIGHT see oil below $100 by year end, only to see it double in the next five years or less.

[SWRichmond]

I've done a quick calc and I'm trying to get comments.

This Bloomberg article:
www.bloomberg.com/apps...

contains this sentence: "About $11 trillion has been erased from global equities in 2008 as more than $460 billion in credit-related losses and accelerating inflation threaten global economic growth."

I find this number very interesting, for several reasons. First of all, did anyone know that $11 Trillion had been "erased"? That's a goddamned big number. Second, the number illustrates financial leverage working in reverse. We have all heard about how the banks are leveraged 20 to 1 or more, and how this leverage works in their favor on the upside. Well, if we have suffered $ 460 Billion in credit-related losses and as a result "erased" $11 Trillion of equity, that is 20 to 1 leverage working in reverse.

Next, just how big is $11 Trillion? GDP of planet earth is about $60 Trillion. According to the CIA Factbook, global equity markets are worth about $50 Trillion, and debt markets another $50 Trillion (2005/2006 data). So, if I am correct, we have just lost 10% of the equity in global markets.

Bill Gross of PIMCO says he expects the total credit-related losses to be about $ 1Trillion. Others have said from $1 to $1.5 Trillion. So at this same 20 to 1 leverage, we are going to lose another 10% of global equity, or more. These numbers are huge, and no one really understands what they mean except that they are really big. I'd dare any talking head to tell me we're almost out of the woods.

Obviously the deflationary pressures are freaking other-worldly, unimaginable, epic. I expect these epic deflationary pressures to be met with an epic inflationary response.

The US Democrats are already acting Like Obama is going to get elected. Larry Summers was on CSpan the other day while at a talk a Brookings (where else). He was suggesting another stimulus package was needed, and also wanted to do "infrastructure projects" like bridges, roads, etc. You know, WPA stuff like my granddad did during the Depression. This will probably be the source of the inflationary response. I am beginning to believe that we are going to have another Democrat with another New Deal.

[SWRichmond]

Article didn't paste right...try this

www.bloomberg.com/apps...

[Ames Tiedeman]

Good points Richmond.

[Aly-Khan Satchu]

The dollar is rallying because nearly all the bad news is in the price. The bad news is not in the price elsewhere. I think this rally will gain real traction and that the ascendancy of Barrack Obama will completely change the way that International Investors look at the US. The US Real Estate market has already adjusted with a vengeance, the others [especially in Europe] are still playing at the edges. I like 1 year calls 1.40 strike versus Euro.

Aly-Khan Satchu
rich.co.ke

[JAZ]

I think Aly-Khan got it right in that the US markets and the dollar have already been taken to the woodshed, other economies are lagging both in terms of feeling and fixing (by reducing rates) the pain. So on a relative basis US rates will rise in the short term supporting the dollar. In the longer term the dollar is toast until the deficits at least stop growing.

[Coelacanth]

Has the dollar's death been called prematurely?

Stalled exports from a an over valued euro is a slow burn down. In the near and maybe medium term the dollar will perculate. To get real long-term traction America needs to fix it's financial house.

The EU is about to find out if the twelve stars on their flag are in deed symbolic of unity and perfection.