Guest post: Dollar weakness continues

Submitted by Edward Harrison of the site Credit Writedowns.

As I write this, the U.S. dollar has fallen to new 8-month lows against the British Pound and oil. Sterling is up over 2 big figures to 1.6371 while oil (WTI crude front month contract) has marched up near $68 a barrel. Clearly the sell the dollar meme is still in effect in this new month. I should also mention that treasuries are getting crushed again with the yields on the 5-, 10- and 30-year all increasing 10 basis points. Treasuries had rallied at the end of last week.

The currency team of Brown Brothers Harriman had this to say ahead of the market open:

Momentum traders have contributed to the dollar’s sharp losses in recent weeks exacerbating the fall. This is important because it suggests that the dollar’s move is not being driven by fundamentals at the start of a longer term US dollar trend lower but by market participants jumping on board a moving train. This also suggests the move is likely to come to an abrupt end at some point. Evidence that momentum traders have played a key role in the dollars slump appears in IMM data. Since the end of the first quarter IMM speculators have shifted from being short a net -135,902 of foreign currency contracts held against the dollar to a net long position of 84,848 of foreign currency contracts in the week ended last Tuesday, a 220,750 shift in positions. Details show that net long euro positions, at 15,584 contracts in the latest week, are now at their longest since July 2008 and close to the 2-year average. However, position size does not imply that the market will correct lower. Net long euro positions remained above current levels for much of 2006 through early 2008 as the euro trended higher. One notable factor is that momentum indicators are beginning to diverge. The euro hit a new high today but the RSI remains below Friday’s high. Still, the euro has continued to advance and as we noted in our piece “Questioning the Dollar” the euro could rise toward $1.4600-$1.4800. For the Swiss franc, the RSI diverged last Thursday when the currency hit a new high but the RSI did not. That is not the case with most other major currencies however.

There is no evidence so far that momentum indicators are pointing to a correction for the dollar bloc currencies which all set new highs for the year today even though Australian dollar positions which quadrupled to 32,469 contracts from the end of March to the highest since August 2008, are now above the 2-year moving average; Net long New Zealand dollar positions, at 12,532 contracts (up from -2885 at the end of March) are at the highest since March 2008. Divergence indicators are also pointing up for the Canadian dollar and British pound. Both currencies have posted gains in April and May as the market cut short Canadian dollar and short sterling positions with net long Canadian dollar positions only emerging in May, a shift of 32,304 contracts from the end of March. The market remains short sterling though net shorts have been reduced 19% from the end of March. Sterling is trading at its highest level in 7 months and with momentum indicators still pointing higher, the pound could reach the mid-$1.60’s before turning lower.

This week’s events, particularly anticipation of US jobs data at the end of the week, may contribute to a shift in momentum indicators in favor of the US dollar. Central bank meetings may have less impact but do create risk events. For today, the data have been upbeat with much better than expected euro zone PMI manufacturing data providing further incentive to buy the euro – in addition to the euro zone PMI, regional PMIs from Germany, France, Italy, Spain and the UK all came in above expectations although below the 50/50 boom/bust level. Similarly, today’s US ISM manufacturing index is also expected to improve after a sting of mostly firmer regional indices. One number that could be somewhat negative is personal income excluding transfer payments such as unemployment.

There should be little evidence of inflation in today’s core PCE data. The report is likely to remain almost rock sold, diverging only slightly from the long term average of 1.8% y/y. The consensus is for 1.9%. Other recent inflation indicators have also shown little sign for concern. Euro zone May CPI came in at zero last week while the five year inflation expectation reported in the Michigan consumer confidence release rose marginally to 2.9% from 2.85% averaged over the past 10 months.

As I indicated in an earlier post last weekend, TIPS are a much better play than Treasuries if you want to be long U.S. government bonds, and the short-end of the curve is much better than the long-end because the likes of the Chinese are now avoiding long-dated Treasuries. The rally in U.S. government bonds was a relief rally because auctions went better than expected suggesting there is still appetite for U.S. paper, but the renewed pressure today demonstrates that the inflation trade is well under way, and that is bad for the U.S. dollar and dollar-based asset markets. This inflation trade seems to be pre-mature as deflationary forces are still of over-riding concern. However, clearly, the Fed will have its work cut out to stop inflation wants the reflationary mechanisms gather steam.

In today’s links, I linked out to an FT Alphaville article by Tracy Alloway which notes that Nassim Taleb suggests hyper-inflation as a ‘Black Swan’ hedge trade. This is a view that has gained currency via Marc Faber ( see my post here.) Personally, I think Faber is making a statement for effect. Nevertheless, the concept of taking out a small hyper-inflation hedge via out-of-the money puts might be a trade of value.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward


  1. ndk

    Back in the dark days of the credit implosion, a lot of people feared that there would be a capital flight from the U.S. I stated bluntly that I thought it quite unlikely, but that the signs to watch for would be a simultaneous rise in yields and drop in the dollar.

    How times have changed. We might just be witnessing re-risking — corporates are faring much better than Treasuries, for example — but on any measure, compared to the USD, it’s looking a little like very mild capital flight.

    I still am very curious to see what China does. Yves once volunteered that depegging the yuan or ceasing the purchase of Treasuries was their nuclear option; I thought “diversifying” into commodities while maintaining their peg was. They’ve certainly done the latter to date.

    While I would immediately concede the likelihood that the U.S. consumer is out to lunch for good — the gain in incomes today was all transfer payments, and the oil standard’s about to punch them again — there are other good reasons for China to peg their currency still. One is limiting the ability of the U.S. to compete with China as exporter to the world. The weight of the U.S. will drag the yuan down, making exports to the rest of the world more appealing as well.

    Will that be sufficient incentive to incur further capital losses on USD investments? My hunch is yes, but really, I have no idea.

    I really am surprised re-risking has gotten off the ground this quickly, and capital flight has occurred so fast. I didn’t see it coming.

  2. Andrew Bissell

    GBP has *already* reached the mid $1.60’s today. Near-term anti-dollar sentiment readings are near records, Bloomberg headlines are littered with news of the coming dollar apocalypse, and the announcement of Taleb’s Hyperinflation Fund seems as good a headline as any to mark at least a near-term top in this stupid “reflation trade.”

    The days of “Don’t Fight the Fed” are over. It is remarkable to me that a mere two month rally in various asset classes is enough to convince everyone to start getting short the dollar again. It is a sign of just how little anyone ever believed in the deflation thesis, and, therefore, of how much further that trade has to run.

  3. ndk

    Andrew, my money is still with you in the deflationary trade. The mosst painful part of being wrong on it is not just suffering capital losses on longer-dated debt, but also that the positions themselves are in a currency of diminished value.

    I don’t see any lasting successful reflation, because I believe the real equilibrium interest rate is negative — we’ve been flirting with deflation for nigh on 10 years now, and China’s been in and out of it — but I’ve got a couple of those hedges Edward mentioned on just in case.

  4. tradelite

    do realize that there are two levels at play here. The instinctive, animal level, where we want to punish those who have done us wrong, while those who have done us wrong have done it following their animal desires. There is also the rational level, of which to I am referring to above.Realistically, I know the beast in us will take over and this will end like it did in France in the 1790’s. I will, however, not be the one holding the sword.

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  5. Andrew Bissell

    I don't see any lasting successful reflation, because I believe the real equilibrium interest rate is negative — we've been flirting with deflation for nigh on 10 years now, and China's been in and out of it — but I've got a couple of those hedges Edward mentioned on just in case.

    I'm definitely with you on this, ndk. However, I don't believe paper assets like options on commodity futures or even gold ETFs are the right way to purchase "insurance" against a hyperinflationary holocaust, because there's too much risk your counterparties wouldn't be able to pay off on the bet. I don't hold any real estate (which actually works brilliantly as a hyperinflation hedge) but I do always keep a reasonable share of my net worth in physical precious metals.

  6. Hugh

    I don’t really follow the currency markets, but the current run up in oil is about speculation in a market that lends itself to leveraging. This is the same kind of speculative spike we saw last year.

  7. mitulsstakeonit

    It’s easy to become overly bearish on the dollar, especially given all the headlines about foreign official investors moving away from US bonds.

    The reality is that foreign official investors such as foreign central banks have maintained high levels of buying of US bonds over recent weeks.

    Both Fed custody data for foreign official accounts and indirect bids at US Treasury auctions have remained strong, suggesting that China and other countries who are big buyers of US debt have not shifted away from US bonds despite all the rhetoric.

    I write about this in more detail in my blog:

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