Saturday, May 23, 2009

Selling the dollar on credit concerns

Huh?

So the UK has been put on notice by S&P that it could be in for a credit downgrade.

Yes, some want to mechanically look at those key financial ratios like debt-to-GDP and extrapolate that fear to the US. But there are differences: the US is not the UK and it is definitely not Europe. It's not that the US can post or carry loads more debt than other countries or that its deficits can be sustained at high levels, but that it has showed resiliency that Europe has not. The US has the ability to grow strongly from a position of indebtedness and make great strides to reduce the problem- unlike most countries in Europe whose growth is less dynamic and whose unemployment rates are normally as high as the US rate gets to be at its high point in the business cycle.  

The cost has risen risen for credit default swaps on US debt but we have to wonder if even that is a direct play on US credit prospects or a roundabout way to bet on overall volatility. 

In a world in which the US was not the best credit quality who would be - and what kind of world would that be? 

Oh, yes the euro area has debt to GDP restrictions on various members' fiscal ratios and budget restrictions to boot. It also is a much less flexible place that would not be able to accommodate the kind of transactions and capital flows we see in the dollar zone. Trash the US credit rating and you'll live in a garbage dump for sure, wherever you live.  Imagine how international capital flows would dry up if the US was no longer thought of as issuing safe debt? On second thought, don't imagine that...  

Moreover, the US is battling a crisis that has very likely seen its worst.  So reacting to the UK news as though it's a wake up call on the US seems a bit out of touch.   

Perhaps one of the oddest things is that after a warning that the UK could get its credit downgraded an extrapolation that the US might be next has sent the pound sterling soaring Vs the dollar. Huh? Buy the rumor IGNORE the fact?  C'mon that's just odd. 

We are seeing the 'best' case of buy the rumor and sell the fact embodied in dollar-selling.  Most likely it is not that at all but classic magician's misdirection. I would not say traders should fight or buck this dollar trend because that is always foolish. I would say these trends are likely to play out soon since the pound and yen are likely reacting to their own oversold positions more than to this 'news'. When the 'credit quality trade' is over, market 'insiders' will find another excuse. By that time the dollar will have stabilized, helped by an improving US economy, that once again will be leading the world into recovery. By Keynesian logic a stronger recovery should weaken the dollar by expanding the US current account deficit. And we have already seen some hint of that. I'd sooner believe that the current dollar selling is related to that than to concerns of a US credit downgrades.   

Things were 'so bad' and credit fears were 'so advanced' that US share prices were rocked but they still rose on the week.  Also as speculation runs wild and pea-brains extrapolate two-point trends, let's remember that in this crisis one of the factors that stabilized markets was the Fed expanding its swap lines to foreign central banks so they could in turn provide MORE dollar financing to their banks. The dollar has been is great demand. Confidence has not been shaken.   

Currency markets can and will flutter. Rumors always have driven markets. Money is usually made by reacting to the sniff of rumor instead of waiting for the hard fact of substantiated evidence. However true that is,  that does not mean that all rumors or early moves by markets are correct. Rumors often are planted or floated to make money for the quick who see the fleeting opportunity for what it is and to catch unawares those who actually swallow the stuff whole. 

Markets fluctuate in part because they anticipate all sorts of things that do not happen or that do not happen on the market's schedule. Then there are things that are surprises. Some events are seen in advance and get discounted. But the markets mash all these sorts of reactions together in hopeless tangle. 

The Obama administration says there is nothing to these rumors and on the other hand whines that it inherited these financial problems. That is a mixture of 'hey were OK' and  '...but if we aren't, don't blame me'.  It's another example of how this administration is having a hard time sending the right message.  That's just too bad and it explains why rumors and conjectures like this have legs even if they have no heart or brain. 
      
  

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