The Buck Stops Where?

Monday, May 01, 2006 | 07:45 AM

Alternate title: The  Buck Flops Here.

A few weeks ago, when discussing my Bearish 2nd half outlook, a guest on Kudlow said  "That could only happen of the dollar really gets killed." I answered that a dollar collapse was only one risk factor facing markets at this phase; clearly, its an important issue for how markets will perform. 

Buck_drops_here Today, the WSJ reports "The dollar is suffering its most painful selloff in months, a trend that could reverberate throughout the stock and bond markets."

As Oil spiked and Gold rallied (or is it the other way around?) U.S. currency fell to an 11-month low versus the euro Friday. Its also at a two-decade low against the Canadian dollar. Last week's drop was the biggest decline in 4 months.

History reveals that as soon a sthe Fed stops, equity Markets rally a few percent, while the dollar sells off hard. The Pause/Resume scenario Bernanke hinted at last week is certainly a motivating force for last week's dollar daze.

The WSJ reports:

Analysts say the biggest beneficiaries of further dollar declines this year are likely to be the yen and other Asian currencies, some of which have been rallying since the fall. The Korean won, for instance, has soared 11% against the dollar over the past six months and is back to levels not seen since the 1997 currency crisis. The yen rose to 113.86 yen last week versus the dollar, a six-month high.

The dollar already was going through a rough patch when it was hit on two fronts last week. The Group of Seven leading industrial nations said emerging economies should let their currencies appreciate to help reduce the large trade surpluses these countries have with the U.S. and other developed nations. Analysts say the G-7 statement represents a step forward from Washington's lone voice and ratchets up the pressure on Asian governments to allow their currencies to appreciate.

Federal Reserve Chairman Ben Bernanke, testifying before Congress on Thursday, offered the strongest indications yet that the central bank might be about to pause after a long period of interest-rate increases. For traders already inclined to sell the dollar, "this was like waving a red flag in front of a bull," says Adnan Akant, a managing director at New York money manager Fischer Francis Trees & Watts.

A falling dollar could mean bad news for the bond market because it can lead to inflation and higher interest rates. While a weaker currency is beneficial for some stocks because it makes their products overseas more competitive, many companies also would face higher costs on goods from abroad."

Things to watch for are weakening consumer staples (Wal-Mart), slowing foreign  capital flows into US investments, a new challenge for Asian exporters (Sony, Toyota). Its a negative for Bonds, as a weak currency is inflationary, and yield will have to rise proportionately to attract overseas investors and make up for thier currency risk. I would expect banks to be problematic also.

On the strong side: Material and energy sectors (Oil & Gold) US exporters and industrial manufacturers  (Boeing, General Electric, Caterpillar and John Deere), Tourism and Travel to the US gets that much more attractive to Europeans and Asians.

Should be interesting, to say the least . . .

>


Source:
Dollar's Slide Could Roil Stocks
CRAIG KARMIN
WSJ, May 1, 2006; Page C1
http://online.wsj.com/article/SB114643421229739935.html

Monday, May 01, 2006 | 07:45 AM | Permalink | Comments (10) | TrackBack (2)
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» The Falling Dollar from The Everyday Economist
The Wall Street Journal reports that the dollar has fallen to an 11-month low. This has sparked worries are higher inflation due to the rising cost of foreign goods due to reduced buying power. However, the fall of the dollar is a prime example of ho... [Read More]

Tracked on May 1, 2006 9:09:04 AM

Comments

This is an article that is a prime example of a reporter not having a firm grasp of economics as Ned pointed out yesterday. Or, to be fair, at least not reporting as such. The article is partially useful in reporting the fact the dollar has been dropping. But it appears he looks on his chart and sees a scenario develop and it says buy inflationary or export driven stocks when the dollar is falling. Yet the price appreciation of inflationary input classes are supposedly driven by Asian demand.

So, if Asian demand for commodities is likely to abate or even fall off of a cliff if their currencies appreciate-because they won't stimulate their own consumer instead choosing to rely solely on exports to the US-, how is that going to fuel further global inflationary pressures? And, without further stimulus of the non-American consumer, how will it help export driven companies in the US that are really shipping overseas for goods and services to be shipped back to the US? In both instances you can have a set up for a scenario to come to pass. But, for it to actually happen, someone other than the US needs to buy something. And not in the interim step of production on the way to its final destination, the American consumer.

This scenario will potentially create an period of deflation or stagflation more than it would create a period of inflation. This is the same mentality of the average mutual fund management team. That is why 90% don't beat their respective index benchmark and 70+% underperform the S&P. If the dollar drops outside of its historical trading bands, we can guesstimate what might happen but we'll likely see quite a few gophers pop up that we didn't expect either.

Something has to give here. Either we have a housing bubble or we don't. Either we have a tapped out American consumer or we don't. Either we have the Chinese miracle or we don't. Either we have a dollar crisis coming or we don't. Either, either, either.

If we have all of these negative imbalances, then our end of cycle scenario is not inflation. It's an asset bubble which will eventually pop. If that happens, we had tremendous intermediate term inflation followed by the end state of asset prices cratering while demand craters simultaneously. It won't matter how much inventory of copper is in London because no one will want it. Why can't people see this? That is how every cycle ends. Instead of asset prices being hard assets, most people are used to it being equities. Commodity prices will go up till they break demand. Just like equity cycles. How can these prices go up so high and not affect global demand? People say they are going to the moon. Those were the same people on CNBC saying houses were going to the moon. Or in 2000, stocks were going to the moon. That's right. They were. Until they shut off demand because they were a self fulfilling prophecy. Markets do work and the Fed doesn't always need to pop them. They usually do that quite well on their own.

Posted by: B | May 1, 2006 8:22:05 AM

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