It appears that China is doing its best to keep the dollar from strengthening, employing a strategy of “covert easing.” Is this Act One of the US-China divorce Harvard’s Niall Ferguson predicted last year, or is this an intervention on China’s part to moderate the short covering rally in the dollar, as a way to hedge its exports recovery? Only time will tell; either way, it looks as though China is selling U.S. treasuries.
The government said Tuesday that foreign demand for U.S. Treasury securities fell by the largest amount on record in December with China reducing its holdings by $34.2 billion.
The reductions in holdings, if they continue, could force the government to make higher interest payments at a time that it is running record federal deficits.
The Treasury Department reported that foreign holdings of U.S. Treasury securities fell by $53 billion in December, surpassing the previous record of a $44.5 billion drop in April 2009.
On the surface, this is a story that is likely to get politicized, used in Washington, as bait for continuance of QE. Scratching below, there is far more to this than meets the eye, in what amounts to a very sophisticated monetary shell game of keeping the dollar moderately cheap that is being played out between the U.S and China. Keep your eyes on the ball. The agenda belongs to China, the recovery in its export sector, and currency balance in the yuan/dollar pair.
The world debt overhang is threatening the world recovery, because markets will realize at some point how risky it is and the yields on bonds will increase, Niall Ferguson, professor of history at Harvard University, told CNBC on Thursday.
“I think we have a situation where Greece is leading the pack but other countries will follow,” Ferguson told “Squawk Box Europe.”
Very few countries were able to cope with debt of over 100% of GDP in the past, and “the classic question is whether or not you default or try to inflate it away,” Ferguson said.
The United States is in control of its currency and can print more to reduce its debt, but Greece and other countries in the euro cannot do this, therefore the cost of their debt will rise, he predicted.
An interesting report on China reveals that 8.0% growth is the minimum GDP growth China needs to achieve in order to keep things there going, and despite the 10.7% print this week, Michael Pettis of Peking University, discusses the fact that without the currency subsidy or the interest rate subsidy, many companies just won’t be able to make money.
Reading between the lines, it seems continued rate hikes as policy tightening, which has spooked world markets and commodities prices, would be premature. While China is experiencing asset price inflation, the export sector continues to be deflationary as there is still an enormous amount slack to take up.
Commodities and the Canadian dollar have continued to strengthen despite the rally in the U.S. dollar. That’s odd, because for nine months, the U.S. dollar was involved in an inverse relationship with commodities, the Canadian dollar, equities, and emerging markets.
That relationship ended in late November as the dollar began its now, six-week old recovery.
It was often reported, from March to November 2009, that commodities prices were rising as a by-product of the falling U.S. dollar. That, indeed was doubly so. Speculative interest in commodities was driving prices higher, while rising short interest in the U.S. dollar, and record deployments of institutional cash were sending the currency lower, against the yen, and euro…
Find out why its possible Canadian stocks, bonds, the loonie, the commodity complex could remain relatively stable, and possibly go higher, though modestly.
Financial markets have been swept up during the last nine months by the Fed’s easy money policies, particularly its zero-interest-rate policy, which fostered a carry-trade in the dollar. Now, as the dollar rallies, and the Japanese economy and yen falter, the short term appointment of the dollar as the primary funding currency may be ending. Some say that it will be dire for markets. Perhaps the best news right now for the US and Canada is the bad news from Japan, of record deflation, and the BoJ’s need to devalue the yen. There’s a good chance the yen will replace dollar, and resume its decade-plus-long position as the world’s primary funding currency, and that’s good news for the market in the longer term. In the near-term transition period, however, markets will be volatile, as one carry unwinds, and the other re-winds.
Barry Ritholtz shares an interesting note on the rally in the dollar. The MACD has turned up and crossed over, signalling that traders and U.S. dollar carry-traders are nervous about their short positions in the dollar. With the Japan-easing underway, its possible that during the course of the year, the yen will replace the dollar as the primary funding currency. Time to bet on a return of volatility in risk assets.
On another note, the Canadian dollar is set to weaken relative to the greenback, should the rally in the dollar gain traction.
We know that “Short the US Dollar” has been a crowded trade for some time now. And, after falling 41% from 2001 to 2008, the fat part of the collapse has already happened.
Will it continue? That’s what today’s chart looks at.
How likely is it that the rest of the world will stand idly by and allow: a) US manufacturing competitiveness a huge advantage via weak currency?; 2) Massive US debt to be inflated away through dollar weakness?
Quite possibly not, as other currencies engage in a race to the bottom. The chart below suggests a dollar rally is in the offing: >
Adam Hewison strikes again with the ten-thousand-foot-view of the market with three new technical analysis videos on the Dollar Index (DXY), Crude Oil, Gold - These are relevant analyses given that crude and gold are both priced in US dollars:
The above chart is Adam showing the declining trend of the US Dollar Index along with the positive (standard) MACD Divergence… and the recent positive trendline break. As such, his video is entitled:
“The crude oil market continues to soften and is now close to some important levels that I think we should look at. In my new video we look at what is happening in this market right now and what we expect to happen in the future.
Advertisement
As we have indicated in our earlier posts, we are now in the official “silly season” for trading. What I mean by that is the markets will be very thin, choppy and can be moved by a relatively small amount of money.”
Finally, Adam posts a quick 3-min update on Gold strangely titled:
We are already in the “silly season” and what I mean by that is after December 15 most traders are not serious about the markets and they’re not committed to any large positions for the balance of the year.
As you will see in the video, gold has fallen back to an area that should provide support, however it will remain choppy and thinly traded for the balance of the year.”
The dollar is likely to continue depreciating and the “new normal” will see consumers shedding debt in an attempt to balance their books, Bill Gross, the influential manager who runs top bond fund Pimco, told CNBC Wednesday.
“I think the dollar is an over-owned currency. The Chinese, the Asians have basically owned too many dollars for too long,” Gross told “Squawk Box”.
The government has increased borrowing and this will make the dollar “more and more owned and less and less desirable” but this is necessary for balancing the world economy, as it may result in higher production in the US and lower production in China.
The chart below comes courtesy of Andy Kessler and shows the strong relationship between the movement in the Dow Jones Industrial Index and the monetary base. The monetary base data is defined as the “sum of currency in circulation, reserve balances with Federal Reserve Banks, and service-related adjustments to compensate for float”.
The extraordinarily loose monetary conditions will not last indefinitely and the main head wind for stock markets to look for will be a tightening monetary policy, eventually followed by an inverted yield curve.
“The Fed and the Obama administration seem to be pursuing policies that are dollar-negative, and they give no hint of letting up,” said John Mauldin (Thoughts from the Frontline). I share this view and alluded to this in July (see “US dollar about to pop“) when I pointed out that the devaluation of the greenback was a likely policy tool to stimulate the US economy.
The combination of low interest rates and quantitative easing has made the US dollar an attractive currency for funding carry-trade transactions (i.e. selling low-yielding currencies to finance the purchase of higher-yielding currencies) and spells more downside, at least until the Fed starts withdrawing from its very loose monetary policy.
As investors started assuming more risk since March, the US Dollar Index headed lower, hitting a one-year low yesterday and trading in a confirmed downtrend as far as the key 200-day moving average and other primary trend indicators are concerned.
Considering the short-term technical picture, Adam Hewison’s (INO.com) short analysis provides valuable insight. Click here to access the presentation.
“For those interested, below we highlight the 25 largest companies in the world. For each company, we provide its country, sector, price (local currency), year to date change, and market cap in dollars. As shown, Exxon Mobil (XOM) is the biggest company in the world and the only one worth more than $300 billion. PetroChina ranks second and is the only other company worth more than $200 billion. The Industrial and Commercial Bank of China is the world’s third largest company, giving China two of the biggest three. Wal-Mart and Microsoft round out the top five. The United States still dominates the list with 12 of the 25 spots. China ranks second with four spots. General Electric used to be the biggest company in the world, but it has slipped all the way down to the 18th spot. Google (GOOG) is also on the list at number 22.”
Hugh Hendry is bullish on Government Bonds, the long-term kind. In particular, he likes the German 30-year Bunds, which currently yield 4%.
“We are going through the biggest deflationary recession in 50, 60, 70 years. The price [of the Bunds] is wrong.
Hendry is long the US dollar, the case being that as long as the economy is delevering, assets being sold to retire debt, that the end result in the present is that the economy is long the dollar, hence the hard to explain strong dollar.
Hendry goes on to say that he is short sovereign credit, in particular, China, Korea, Mexico, Hungary.
On the subject of US solvency and dollar strength Hendry points out that the US entered this crisis with public debt levels at of 40% of GDP. Japan entered entered its crisis in 1990-91 with similar levels, and today Japan’s public debt levels are 200% of GDP; the remarkable feature here is the strength of Japan’s currency. This 4-fold expansion of public debt may not be the case in the US, but Hendry points out that we’ve got a long time to worry about the US, and whether or not it may have a solvency problem down the road. On the basis of the delevering World economy, Hendry is long the US dollar.
As for gold, Hendry makes himself clear that “too many people today, can articulate its very valid attractions; there are too many people owning gold today, you can’t buy coins today unless you pay premium prices for them.
“Making money is a devastatingly hard business. If I own gold and I open up the paper in the morning and the price of gold is telling me how smart I am to own gold, that is not the recipe for making money. You want to pick up the paper, and be owning government bonds, and every expert is telling you you’re wrong. It feels lonely, it feels horrible! That is how you make money.”
One of the most refreshing aspects of Hendry’s willingness to share his ideas openly, is that even he recognizes that most folks don’t want to agree with him. If you listen carefully, Hendry is not interested in being a doomsayer, he is interested in the opportunities presented by the current market conditions.
This interview is a great lesson on global credit and equity markets and economics, as Hendry eloquently shares his insight.
By the way, Hendry’s Eclectica Fund has been a star performer during the last year with returns of around 40%, most of which has come from investments in bonds. Hendry even temporarily violated the mandate of one of his long-only equity funds by investing in a majority of government bonds and then subsequently went about the process of changing the investment policy to include the allowance for bonds.
Check out global government bond funds. They are reflection of Hendry’s primary argument. If Hendry is right, we are in the midst of a global bond bull market, as a result of the massive amounts of delevering that is underway, in the debt ridden G6 world.
Commodity price performance has been a wild ride in 2008. The record of price movement is outlined in the table and chart below. For each commodity, the table details year-to-date (YTD) %-age change, drop from 52-week high, and start of year to the 52-week high.
Oil has had the roughest ride falling 62% YTD, 75% from its 52-week high, and preceded by a rise of 53% to its 52-week high. This was followed by Copper, Platinum, and Natural Gas, which had a meteoric rise to its 52-week high of 83%.
Most of the commodities, save Gold, have behaved in kind, thanks to the long-only commodity indices like GSCI which enabled investors of all kinds to invest naked in long-only baskets of commodities. They all went up together, and they all came down together. Platinum and Silver, the other two precious metals dropped along with other commodities, while Gold resumed its dual status as favoured currency and store of value during periods of turmoil.
Commodities are indeed more volatile than stocks. When, and if, we see the return of expansionary and/or inflationary (or worse, hyper-inflationary) conditions, however, these will be a key asset class to allocate to. With all of the printing presses at the Fed whirring right now, some would say its inevitable.
Stay on top of the latest headlines from the Wall Street Journal Online.
WSJ What's News Late Edition, March 10, 2010by The Wall Street Journal 10 Mar 2010 at 4:51pm
Stocks inch higher with the NASDAQ posting the biggest gain; wholesale inventories drop unexpectedly in January as demand surged; and the government posts its largest monthly deficit ever.
Jeffrey Saut Daily Audio Comment Raymond James
Listen to the recording with one of the media players below:
Jeff Saut’s Daily Audio Comment is recorded every weekday, except Wednesday, at 9 a.m. ET. It is made available to the public on this Web page at approximately 1 p.m. ET.
