Sunday, November 07, 2004

Whither the Dollar? A trader's view

Rumors from the financial world:

"Interesting read.   As tomorrow's FT article points out below, if the dollar doesn't rally on strong payroll #s, something fundamentally may be changing.  What is it ? Potentially foreign governments cutting exposure to US assets.   Article cites China, India, Russia and other Middle Eastern countries selling $s. Widening US budget and current account deficits can't be helping either on a 'secular' basis."

From FT: Many currency traders were taken aback on Friday when the greenback fell in spite of bullish data showing the US economy created 337,000 jobs in October. "If this can't cause the dollar to strengthen you have to tell me what will. This is a big green light to sell the dollar," said David Bloom, currency analyst at HSBC, as the greenback fell to a nine-year low in trade-weighted terms.
Speculative traders in Chicago last week racked up the highest number of long-euro, short-dollar contracts on record. Options traders have reported brisk business in euro calls - contracts to buy the euro at a pre-determined rate. However, the market has been rife with rumours that the latest wave of selling has been led by foreign governments seeking to cut their exposure to US assets.

The view of an amateur (me!):

The dollar may fall on rumors, but I doubt seriously whether the BoC (China) has really decided to abandon the dollar. For such an important decision, even were they ready to do it now, I imagine they would want to watch the new Bush administration for a while to see what is happening.

If the dollar falls too much against Asian currencies (Yen, Yuan), there will be a real problem as the J economy could slip back into recession and the growth in China would slow to the point that they are not creating enough jobs to handle the flow of migrants into the urban areas. That would lead to social unrest.

I think the RMB peg will not go away for a couple of years (certainly not fully - a wider trading range is possible, though). Recall that James Baker helped negotiate the Plaza Accord, which devalued the dollar by about 40% in the mid to late 80s, but in an orderly way. I would not be surprised if W puts together a similar deal, although I also would not be surprised if they continue their "benign neglect" of the USD and the market takes it out of their hands...


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