Dollar Bears Relish but End of QE II Spells Trouble
Montreal, Canada
There’s no denying the secular long-term trend of the American dollar. In the absence of significant spending cuts and big cuts in entitlement spending, the dollar will remain hostage to selling as investors chase superior growth rates accompanied by smarter balance sheets. Gold’s charge to newer highs confirms the dollar’s latest freefall.
Many central banks have started to tighten monetary policy at a time when the Fed will either stand pat or gradually begin hiking rates later in 2012. This implies many foreign currencies continue to draw a yield advantage at the expense of the Fed.
It’s pretty hard to find a dollar bull these days. If there is one, you’d suggest a good doctor to have his head examined. The dollar is now breaching all sorts of technical support levels against most foreign currencies, including the widely watched U.S. Dollar Index. Everyone loves to hate the dollar.
But when everyone is on the same side of the boat, danger lurks.
More often than not, investors trade down risk as we approach the summer as seasonal factors force a retrenchment of risk; I suspect too many investors are diving into equities and commodities and dumping the dollar without fully understanding how the market can tilt the other way. It’s not always a one-way street. The summer is usually a bad time to invest.
Still, investors have grown accustomed to the Bernanke call option; every time the market or the economy runs into a draw-down, we can expect the Fed to drop several hundred billion dollars to breathe life into the bulls. This sets a dangerous precedent, almost like we’ve become drug addicts in the world of financial markets, desperately counting on Bernanke to fuel our risk-based appetite.
The Fed is really stuck in a corner. As QE II draws to an end in late June, interest rates in the United States must rise and the dollar might surprise everyone by attracting a bid, at least over the short-term. But the damage might be severe if the bond market unravels too quickly after the Fed leaves the party.
It’s pretty hard to imagine who will replace the Fed’s massive string of purchases at Treasury once the spigots close; Bill Gross at PIMCO is right on the money; it will soon pay to bet against T-bonds because nobody – not even the mighty Chinese – will replace the Fed’s coffers and absorb upcoming supply. Get ready for a bumpy summer and maybe, a stronger dollar, at least temporarily.
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