Friday, June 16, 2006


US Dollar Bears Fear The Fed

Daily FX looks at what is moving the currency markets of late. "Whenever we look at economic data, we use the information to extrapolate what the Federal Reserve will do with interest rates. However in recent weeks, the extrapolation has become far more difficult since US data has been telling us one thing while the Federal Reserve has been telling us another."

"So far, there have been signs that the US economy is weakening and that the odds are building against the dollar while at the same time the Federal Reserve has been telling us that inflation has become so problematic that they have to keep on raising interest rates. Today’s batch of economic data makes figuring out whom to believe even more difficult. Jobless claims and the Empire State manufacturing survey both came out strongly, but the report on net foreign purchases of US securities (also known as the TIC report), industrial production and Philly Fed surveys all showed weakness."

"Since the TIC report was the day’s most important release, the market tried to send the dollar lower, but traders were fearful of shorting the dollar too significantly in an environment where the Fed fund probability for a June rate hike is at 100 percent. The Treasury International capital report was extremely disappointing today, coming out at $46.7 billion compared to a forecast of $60 billion."

"The report indicated that foreign investors did not buy enough US dollar denominated investments to plug the April trade deficit of $63.4 billion. The weakness of the dollar and central bank reserve diversification into Euros has played a big role in the weaker demand. The biggest selling was from the UK which is frequently thought to include investments from the Middle East."

"For now, this may be written off as a one off phenomenon, but if weak demand persists for another month, it will become a far more pressing concern. The market currently has its focus centered on what the Fed will do at the end of the month, but once that passes and we see the next TIC report the following month, then another weak number will be met by a larger reaction in the US dollar."

IMO the writer is correct in noting that all dollar and gold bets have been shaded by the pending Fed action. But what about after? Is the US$ a place to be if the US is in a recession? With all the debt in place, one has to wonder.
If it weren't for the amount of debt tied to the housing bubble in the form of adjustable rates (refinance to a fixed?...not going to happen with the initial fees and then higher monthly payment...most can't afford to do it), the FED wouldn't be in such a pickle. The housing debacle is the fly in the ointment, and the FED knows it. All they can do is talk. ACTUALLY raising rates will put a nail in the coffin. Where the paper money flows is anybody's guess.

I agree completely. The Fed is talking a big game in which they are increasingly a little player. No amount of Fed policy can change the fundamentals. A stronger dollar is a death sentence to both US Manufacturing and housing. The only possible upside of a strong dollar is cheaper oil, but in an otherwise deflationary environment that adds little to the economy. My guess is that the Fed, as you said, knows housing is the 800 lb gorilla in the room, and they'll defend the dollar until the effects of a housing crash start to extend into the banking infrastructure itself. Then it will be time to lubricate the system with cheaper dollars. What that may mean is a year or two of low metals prices, and then the big ascent northwards.
more a two edge sword I think...

Kill the economy ( mostly housing) or raise rates to placate Asian bond buyers. Who will finance our debt?
...and if you havn't notice they are leaving the table ,and buying is down. Now what?
More and more it looks to me like we're going to get a rate raise combined with a monetization of debt. Which of course, is a net expansion of liquidity. But the markets seem fixated on rates as the determinant of the national stance on inflation, rather than growth in money supply.
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