The king maker


Long-term traders in the currency markets know that sentiment tends to be affacted by one or two structural drivers at any one time. Of course, there are thousands of things going on at one time, but the big drivers of currency prices tend to be fairly simple ideas. In this way, markets are like any other human pursuit. Music, fashion, sport and art tend to have one or two major ideas that drive innovation for a period because the participants move on to the “next big thing”. In the present currency markets, no one is under any illusion about the current big driver: US dollar weakness is THE big story.

Don’t trust the media

If you have keep abreast of the financial media over the past six months, you would have heard about the storming Aussie dollar, the rise in gold and other commodities, and the push higher in the Dow Jones Index (now only 10% down from its all-time highs).

But these movements have all been driven by the US dollar. The US government’s move to jump-start economic growth through the devaluation of its currency has become the single biggest factor in not just currency markets, but right through the global financial industry.
And the next instalment of this long-running saga is just around the corner…

What the Fed giveth…

There is plenty of speculation at the moment that the reason we have seen a sharp fall in the prices of most major asset classes since the start of May is down to US government policy.
As we discussed earlier, the strong move higher in a number of asset classes has been driven by the US governments quantitative easing program.
In a nutshell, quantitative easing is the next step a government takes when it can’t cut interest rates any further. And, with interest rates in the US now below 0.25%, there isn’t any room for further cuts.
Instead, the US government, through their central bank, the Federal Reserve, has decided to inject more money into their economy by printing more money and using that money to buy back many of the government bonds that have been issued by the US government.
This has the impact of injecting more new cash into the economy.
The Federal Reserve has embarked on two periods of quantitative easing. The first period started in November 2008 and, while halted briefly last year, continues to this day.
The second stage, known ubiquitously as QE2, began in November 2010 and is scheduled to finish on June 30.
According to many analysts, this deadline to expiry could be one of the driving factors behind the recent weakness in financial markets.

 Is the end nigh?

Orb Investment Management managing director Akhilesh Kamkolkar is one of the more bearish market participants.
“Starting in January 2011, the Fed left a paperweight on the print button,” he said. “Since that time, it’s put $500 billion into the system. When you combine the $100 billion in liquidity provided by QE2, we’re talking about $800-900 billion entering the financial system in 2011 alone.
“Consider that during the first stages of quantitative easing, the Fed was putting roughly $50 billion into the system. But once QE2 was announced in November, the Fed began putting $100 billion into the market. And the Fed is now pumping $200 billion into the system!
“Small wonder then that the US Dollar is falling off a cliff. Indeed, the way things are going, the Fed will push into a full-scale inflationary collapse within three to six months.
“If you’re not preparing for mega-inflation already, you need to start doing so now. The Fed will continue to pump money into the system 24/7 and it’s going to result in the death of the US dollar.”

When will it turn?

When will the US dollar turn? First of all, there’s no reason why it has to.
The US dollar could remain in a weakening phase for years, decades or, if some of the gloomiest analysts are to be believed, until the US currency and economy both collapse and the country is forced to issue new currency – which could well be made out of rock.
However, many analysts believe that like all market movements, sentiment toward the US dollar will ebb and flow. From this perspective, the US dollar is likely to remain in this extremely weak position only until the market sees a decisive pick up in the US economic growth.
According to Riccardo Briganti, the head of research at Macquarie Private Wealth, there are a number of factors that could continue to weigh on the US dollar.
“When we hear that the Fed is looking to rein in inflation, then we might see the US dollar start to move higher,” he said.
Briganti believes we are unlikely to hear such commentary from the Fed until later this year. “Until then, the most likely trajectory for the greenback is sideways or lower.”

Trading US Dollar weakness

What are some of the markets that will do best from long-term US dollar weakness? Clearly, taking positions against the US is the major way to trade this viewpoint.

In the foreign exchange markets, traders have been selling the US dollar against reserve-type currencies such as the Japanese yen and the Swiss franc.
The Australian dollar versus US dollar (AUD/USD) pair has been one of the best-performing trades over the past year as the Aussie dollar was helped by the developed world’s highest level of interest rates.
The commodities markets have also been helped by the falling US dollar.
Commodities are usually priced in US dollars so any fall in the value of the greenback will result in gains in the price of US dollar denominated commodities.
As a result, we have seen both silver and gold double over the past couple of years, while soft commodities have also increased by close to double.
Analysts believe that these movements are likely to continue as long as the US dollar continues to weaken.
So traders should be looking to keep a close eye on the US dollar for signs that this mighty move in equity markets, commodities, and risky currencies, which has dominated trade for the past 10 months, is coming to an end.

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