FYI | Jul 19 2010
GaveKal reports:
This is an odd time in the markets. On the one hand, central bank reserves held at the Fed are growing at the slowest pace since 2002 (which should indicate fewer US$ on the international markets) and US MZM growth is now in negative territory (which should indicate a shortage of US$ domestically)… but yet, in recent weeks, the Dollar has been taking a beating against the Yen, Euro and GBP. So the supply of Dollars is increasingly constrained, but yet its price comes down; how can that be?
The conclusion that we come to is that the market must be betting that this situation will not last and that the Fed will once again open the spigots wide. This is a possibility that we have discussed in various dailies over the past few weeks (see Renewed Fears on Deflation, Credit Easing-Part Deux, Western Doves, Asian Hawks, The Next Step From the Fed…), and one which became clear with the release of the latest FOMC minutes. Indeed, much of the talk om the previous meeting in April had focused on when and how the Fed should start selling the $1 trillion-plus of mortgage-backed assets bought during the crisis.
In the June meeting, however, discussion about taking additional steps to support the economy resurfaced —though, as our readers know, no concrete steps were announced. Still, this brings us to what may today be the single largest reason for the US$ weakness: at this stage, the level of policy uncertainty is probably greater in the US than any other major economy. It is amazing the difference a month can make!
Today, the policy visibility out of Europe is fairly high: governments have by and large agreed to fiscal tightening plans of various amplitudes and the ECB is on the hook for an easy monetary policy which will likely have to become easier over time.
In Japan, the recent electoral defeat of the DPJ likely means no change to the current status quo of very limited budget expansion and a BoJ that continues to sit on its hands (see Kan Can’t). In Asia, central banks in many countries are already busy draining the excess liquidity provided in 2008 (see Asia’s Paradigm Shift). But in the US, the policy mix remains highly uncertain.
On the one hand, the Administration would probably like to get another round of Keynesian stimulus through the door before the preparations for the 2012 presidential election get going…but this will of course be dependent on the result of a November 2010 Congressional election which looks increasingly unfavorable for the Democrats.
On the other hand, if the Administration continues to deficit-spend its way to prosperity, will the Fed be able to remain on the sidelines? Or will the Fed pre-empt another round of fiscal stimulus through a monetary stimulus? It is likely that these uncertainties are currently weighing on the US$. What is more surprising is that they are not weighing on the US government bond market.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
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