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The currency is rising of the country that has defaulted multiple times in the past century and is likely to default again in the next year or two. The currency is falling of the country that has never defaulted and is unlikely to default now. Special circumstances aside, doesn’t this mean that traders are yahoos ignorant of financial and economic history?
Yesterday we complained about short-term thinking among traders but clearly this outcome suggests other currents deep under the water, and more than just the usual anti-dollar bias arising from the US’ twin deficits and other flaws. We are not sure, but let’s take the US budget as the key factor today. The budget is one of those situations where what rules is “be careful what you wish for.”
You’d think that if defense spending gets cut this time (as it does after every war, although usually by Republicans), the world would like the dollar better, because the world will not necessarily be a better place with less US intervention, even if it keeps botching interventions in recent decades. The world has no other military power with the ideals to right wrongs. The French were offended when outgoing Defense Secretary Gates mentioned that France lacks the military chops (and materiel) to carry out the Libyan missions and had to get bombs and things from the US—but we have no reason to think Gates was misrepresenting the situation. Removing the US ability to intervene increases risk for everyone and makes the safe-haven dollar more attractive—doesn’t it?
Another big cut is likely federal government subsidies to agriculture. This might be good for the US fiscal condition but we have yet to see the effect on world food supplies at a time when starvation is rising. Bottom line—everything thinks on both sides of all oceans that the US should clean up its budget act and cut, cut, cut but they fail to recognize the unintended consequences and unrecognized beneficiaries of US overspending. We might even say that a good budget will draw capital to the US not out of relief over fiscal probity but out of fear of the fallout.
The calendar today includes the final June University of Michigan consumer sentiment index (probably a drop), the June ISM manufacturing index, construction spending for May and June auto sales. Bloomberg reports that the ISM factory index will likely fall to 52 from 53.5 in May. Offsetting potentially bad US data is that several of the emerging market PMI’s are clustered near the 50 boom-bust line, as Market News notes, and it’s conceivable that drops under 50 could trigger risk aversion.
As noted at the beginning of this report, we don’t know whether the market is just unwinding risk-off trades or actively entering new risk-on trades. Market News says “Traders anticipate continued volatility in the weeks ahead, with lingering concern about Greek debt restructuring, the U.S. debt ceiling, and the health of the global economy preventing a larger risk rally.” Nimble traders may do okay over the summer but this is not a time for longer-term positions. That implies trend-followers (including us) are going to get whipsawed to death, as happened in June with big intra-day reversals that make a mockery of stop-losses. We see the euro as seriously vulnerable to new developments in the Greek soap opera—yesterday and today it plummeted, if only briefly, onbad news items. The market is eyeing a possible slowdown in emerging markets, too, and that could bring the dollar back into favor as a safe-haven.
We can fall back on the interest rate story—Europe is able to raise rates and the US cannot/will not. Besides, longer-term US yields may fall back and we don’t know how banks are going to manage now that QE2 is over. It looks like the euro has a tailwind, but the sea is choppy and the wind can change in seconds. Our best advice is to take the holiday.
SPOTCURRENT POSITIONSIGNAL STRENGHTOPEN DATEOPEN RATEPOSITION GAIN/LOSS USD/JPY80.79LONG USDWEAK06/17/1180.400.48% GBP/USD1.6005SHORT GBPWEAK06/17/111.61330.79% EURO/USD1.4498SHORT EUROWEAK06/17/111.4220-1.95% EURO/JPY117.13SHORT EUROWEAK06/17/11114.30-2.48% EUR/GBP0.9057LONG EUROSTRONG06/29/110.90550.02% GBP/JPY129.30SHORT GBPSTRONG06/13/11130.741.10% USD/CHF0.8464SHORT USDSTRONG05/27/110.85751.31% USD/CAD0.9631SHORT USDSTRONG06/29/110.96600.30% AUD/USD1.0708SHORT AUDWEAK06/29/111.0565-1.35% AUD/JPY86.51LONG AUDWEAK06/09/1186.230.32% USD/MXN11.6918SHORT USDSTRONG06/29/1111.74270.44%
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