Why I Am Bearish On The US Dollar

The past two days have been remarkable in terms of the volatility in the equity markets, but how has the US dollar performed? Ironically the dollar rallied on risk aversion the one day, and then rallied on renewed optimism the next. Where we are sitting now is likely in overbought territory, at least in the short term, but most likely the longer term as well.

The Global Outlook Weakens

A lot of the dollar’s recent strength can be attributed to the global outlook (non-US) weakening and the re-coupling of risk appetite. Essentially people have realized that the U.S problem will affect the rest of the world and thus their respective currencies have been weakening. Things look particularly bad in Britain and Europe, Russia has also been experiencing lots of turmoil and Japan’s Tankan survey today can best be described as terrible. The weakening of the global currency markets and the expectations that global interest rates will decline and additional liquidity measures will be needed have led to a ‘flight to quality’, as it is called. Essentially U.S treasuries have rallied putting yields into significantly negative real return territory and thus gold has rallied. The irony here is that all this bailout news has put the weak U.S. government’s balance sheet into the spotlight, yet the dollar has rallied. This systemic rally can best be described as strength by default.

First The Short Term

Taking a look at the hourly USD Index chart, it is easy to see that MACD is trending in significantly over bought territory. Technically a short looks like a great trade, but one must be careful as to how they play it. Assets such as oil, the Aussie, and the Canadian Dollar will strengthen against the USD if the bill is passed and risk appetite increases. Gold, the Yen and the Swiss Franc will rally if risk appetite declines, likely in the case that either the bill doesn’t pass, or it passes in a weaker form that doesn’t instill confidence in the market. Either way, the prudent trader should be risk neutral and focus on the over bought state of the dollar itself. Create a basket of your choice and hedge any direction in risk appetite. Oil and gold both rallied through dollar strength today and yesterday respectively, so you may want to stick to the pure currency plays.

Long Term

Can any bill truly support the markets in the longer term? My definitive answer is no, partly because congress doesn’t fully understand the problem and also because they do not respect the size of the problem. As soon as the MBS problem is ’solved’, the market will likely turn its focus to the CDS problem, which may very well be larger in dollar value than the mortgage issue, at least in nominal terms. There’s a limit to how much bailing out can occur.

Ultimately, I believe the U.S will get hit harder than everyone else, primarily because they were the most levered at the peak. A similar downturn in global markets will have a magnified effect on the U.S, followed by Britain. It’s likely that the U.S will be forced to allow foreign sovereign funds to go on a shopping spree in the U.S when no private firms are in the position to shore up the sort of capital that will be required to sustain the U.S economy. This puts the U.S currency at a disadvantage to its global counterparts.

Precious Metals

My last article, which was a while back, highlighted my negative stand on precious metals. Silver was trading in the early 20’s and gold around $1000 an ounce. I was ridiculed for my position that they were both getting expensive and I had taken profits. I’m embarrassed to say that I didn’t buy gold when it dipped under $800, but I did buy silver at $10.50. I am now once again a precious metals bull. This is in part because of my bearish stand on the dollar, but also because of the global view that pumping liquidity into the market is the only viable solution.

That’s not to say that I don’t believe the market needs the liquidity, but right now a lot of it is getting backed up in the banks, who are using cheaper borrowing costs to shore up their own capital position and not pushing that credit out into the market. Credit doesn’t expand when the banks don’t pass it on, so the central banks pump more in. I am confident that it will reach a point where this excess credit will explode out of the banks and the central banks won’t be able to time the removal of all that excess credibility… hence inflation.

Crude Oil

Although this article is focused on the dollar, you cannot ignore the implications of the dollar on oil. Crude will likely remain volatile as demand destruction and a weak dollar battle to be the dominant theme. I will look to buy on dips, primarily through ETFs, and also keep an eye on the major integrated oil companies. If they get hit hard in risk aversion and crude takes a hit, it may very well present some good buying opportunities.

Summary

Regardless of what happens with the bailout, the implications for the dollar are bad. In addition, the global outlook for the dollar is currently net positive, which makes it a more attractive time to take a negative position as a contrarian. The U.S economic situation will likely weaken either way, and a bill getting passed simply makes things worse for the government’s debt. However you look at it, things can’t be good for the dollar looking forward.

Posted in Categories: Canada, Contributor, Economy, Eurozone, External Research, Forex, Japan, Switzerland, UK, USA.

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