21 November, 2003
from commentary posted at www.speculative-investor.com on 20th
case against the US$ has been discussed at length in TSI commentaries
over the past three years. In summary, though, the main driver
of the dollar's bear market is the massive -- and still increasing
-- US current account deficit.
In order for the dollar NOT to fall the US needs to attract sufficient
foreign investment every month to offset the current account
deficit. Therefore, given that US-based investments are unlikely
to offer superior returns to investments in other parts of the
world for many years to come it is highly probable that the dollar's
downward trend will continue until the quarterly current account
deficit is eliminated. At this stage there hasn't been any reduction
in this deficit so the dollar's bear market is clearly still
The current account deficit, combined with the likelihood of
dollar-denominated investments providing sub-par returns for
many years to come, would be enough to make us very bearish on
the US$. However, another major risk for the dollar has emerged
over the past year. That risk is the Fed's absurd plan to keep
short-term interest rates near multi-decade lows for a considerable
period of time in order to combat an imaginary deflation threat.
If Greenspan and Co. follow this plan for another 6-12 months,
as they have intimated they will, then the dollar's decline will
Our view, however, is that the markets will not allow the Fed
to follow this plan beyond the next few months. In fact, we've
forecast that rising long-term interest rates will cause the
Fed to a) switch to a tightening bias by January of next year,
b) make its first rate hike by March, and c) be hiking rates
aggressively by mid-year. The main risk, as far as this view
is concerned, is that foreign central bank buying of US Treasury
and Agency debt will be sufficient, for several more months,
to prevent the bond market from signaling the inflation problem.
If this were to happen then the Fed would have the option of
leaving short-term rates near their current low levels for a
longer period and the US$ would most likely get where it is going
much faster than we currently expect.
Where is the US$ going?
The below long-term chart, which we've included a few times in
past commentaries and which shows the number of US dollars per
Swiss Franc, defines our long-term expectations for the US$.
The chart shows that:
a) The SF has
been in an upward trend against the US$ since the early 1970s.
b) Within the
SF's long-term upward trend their have been two SF bear markets
(US$ bull markets) lasting 6 years that have ended at the long-term
channel bottom and two completed SF bull markets lasting 8-10
years that have ended at the long-term channel top.
If the current
Swiss Franc bull market roughly matches the previous two bull
markets in terms of magnitude and duration then it will end in
2008-2010 with the SF/US$ rate slightly north of 1 (30-40% above
the current level).
expectation is that the SF will work its way to the channel top
over the next 5 years or so. However, the Fed's determination
to hold short-term interest rates at such a low level for a long
time to come creates a risk that the SF will surge through to
the channel top over a much shorter period. Note that during
the mid-1980s -- a period during which the dollar's fundamentals
were not as bearish as they are now -- it only took the SF three
years to go from its channel bottom to its channel top. It then
spent much of the next 5 years in the top one-third of its long-term
The key, as far as whether the Fed will be allowed to be stupid
enough to hold rates near current low levels for another 6-12
months, is the bond market. If bond prices tank then the Fed
will be forced to hike short-term rates because not doing so
would cause a disaster in the stock and property markets. However,
if something is able to prevent bonds from tanking then the Fed
will have the option of not hiking short-term rates (assuming
it is prepared to tolerate a huge decline in the US$).
So, what might
prevent long-term rates from moving sharply higher?
As explained in our 17th November commentary the Fed can't force
long-term rates lower by buying bonds because any Fed purchases
would, by definition, be inflationary (such purchases would be
made with newly-created money). The only things we can think
of that would have any hope of working are the re-emergence of
deflation fears due to extreme weakness in the stock market and/or
an acceleration in the rate at which foreign central banks purchase
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