Wednesday, June 10, 2009

US Dollar: He's no Jedi

Some quick thoughts on the dollar. After the inflation SMACKDOWN from last week, especially my comments that I didn't see a dollar crisis and that foreign investors had few near-term choices but to accept Federation control er-- U.S. Treasuries for the time being, a lot of people are asking me about the dollar.

First a preface that I am not a currency trader, nor do I play one on the interweb. So its possible that the story I'm about to tell is baked in already, or that the dollar is already oversold and could actually rebound from here. But overall, it seems like the balance of factors lean toward a weaker dollar.

I'm a guy who appreciates the classics. Like early 80's sci fi, as you may or may not have heard. Anyway, I see currencies as a matter of relative investment return and relative inflation.

In terms of the big 4 currencies (dollar, yen, euro, pound), the BoJ is already stuck at maximum firepower in terms of monetary policy and the ECB is deluded about economic growth prospects. The U.S. has been much more aggressive in terms of easy money. The BoE is closer to the U.S. model, but still, less aggressive. So of the big 4, the U.S. has pursued the most inflationary path. Now as I've emphasized, I don't expect much in the way of actual inflation, but relative to the other currencies, we should have more inflation. That's dollar negative.

In terms of emerging currencies, I think the relative investment opportunities are greater abroad than here. While I expect the U.S. to keep its head above water, our economy needs to radically change. We haven't even gotten through the deleveraging process yet much less come up with new engines of growth! U.S. growth is going to be anemic for several years. Again, dollar negative.

I can't say what precise level of USD/EUR is right given this view, because like I said, I'm not a currency trader, and besides, I think my view is pretty mainstream. I don't see a crisis, but I also don't see a ton of upside for the dollar.


1 said...
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__ said...

"the ECB is deluded about economic growth prospects."

Please can you explain what you mean by that? The ESCB growth forecasts for 2009 is -5.1% to -4.1% and for 2010 is -1.0% to 0.4%. These compare to consensus forecasts of -4.2% and 0.45%, respectively. Furthermore, the ECB recognises that the Euro-zone has a relatively low potential growth rate due to structural rigidities and that the crisis has lowered this even further (see the Bini Smaghi interview in the WSJ Europe earlier this year).

Thai said...

So you don't see a massive dollar carry trade in place?

gscottl said...

Everything you say makes sense. Most of what Jim Grant says makes sense. Short term rates can't go lower. The yield curve flattened during the crises last fall and recently is steepening. For us traders the question is what is the correct rate throughout the curve. The 10 and 30 overshot on the downside and now may have gotten a little ahead of itself. There is a perception that things could change. Ben is mortal and does make mistakes. I think that is what the market is pricing in right now. The market may now sit back and see if it got it right, and adjust.