The U.S. dollar has been on rampage, setting a new high yesterday of 88.485 yesterday, Oct. 28, up from 73.965 on Aug. 1.
For a long while it was fashionable and profitable to bash the greenback, but one of the first traders I know to call the turn is InterbankFX Chief Currency Strategist Rob Booker, who has ridden that bull for some time. (see the September issue’s cover story, Misery Finds Company).
One of Booker’s FX indicators is the Treasury International Capital Data, which tracks international money flows. The most recent report, released on Oct. 16, showed net Long-term securities transactions have been way down. In May, they were $83.2 billion; June: $53.6 billion; in July, it was just $8.6 billion and August: $14 billion.
Booker says the drop is major and demonstrates that market jitters that have existed for more than a year, have just started to manifest, that the credit crisis is likely to stick around for a while and that the biggest moves may not have happened yet.
“While it seems amazing that the Dow has fallen 40% in one year, and other world markets have made similar drops, the reality is that until now, we really didn’t have a clear picture of where money was going if it was leaving the equities markets,” Booker says. “We thought it was going to come into U.S. Treasuries, and we’re seeing now the evidence that huge amounts of money are leaving the U.S. equities markets and being placed in perceived safe haven investments like government bonds.”
The numbers also show a massive drop in interest for government agency bonds, such as those Fannie Mae or Freddie Mac would sell, and that pullback is dragging down the entire TICs number. “Near the start of this crisis, it’s possible that government agency bonds were viewed as possibly distressed investments or discounted bonds. Now it’s possible they’re just being viewed as garbage,” Booker says.
In order for U.S. equity markets to recover, we would need to see much better numbers and a pattern of improvement. “If the TICs stays below $20 billion for a few months, then we’re essentially seeing the start of a protracted weakness or a bear equities market in the United States. That is a drag on the entire U.S. economy,” he says. “Oddly enough, this would possibly be accompanied by increased demand for U.S. Treasuries, which could act to keep the value of the U.S. dollar reasonably strong. It’s possible that we will see a continued strengthening or at least a stabilization of the U.S. dollar at current levels.”
Booker says the paradox is that the dollar has benefited the most from a crisis that has U.S. roots. “This is the result of one continuing trend: in a slowing world economy, the currencies that stand the most to lose are the ones that benefited the most from a strong world economy in the last four or five years. That is explanation number one for me, for why the dollar has been stronger recently. Number two is an emerging trend, and that’s a flow of money out of emerging market, or riskier economies, and back into what I call perceived safe haven investments, like U.S. Treasuries. As money flows out of riskier investments, it creates demand for dollars, as traders sell investments, like foreign stocks, denominated in emerging market currencies, and buy government bonds denominated in dollars.”
While it’s too early to say the U.S. dollar is starting a long-term bullish cycle, he remains cautiously bullish. “This is why I want to pay close attention to the flow of capital into the United States. I want to see if this bullish movement has legs, and the TICs data is one of the key factors in all of this.”
Booker says the other major beneficiary of this emerging trend is the Japanese yen, which has spent the last eight years as the funding currency of the carry trade. Japan’s interest rates have been exceptionally low and were in fact zero for years. Traders then used that cheap money, borrowed from Japan, to trade markets around the world. “Now borrowers are worried that by the time they have to pay back those loans, the value of the asset will have fallen below the amount due,” Booker says. “So they’re selling the assets, and simultaneously buying yen to pay back the loans. This creates a self-fulfilling cycle, as the asset prices fall further, and the yen rises further.”
He explains the cycle ends only when investors believe the value of their investments will be more stable, or when the Japanese economy is in such bad shape that the yen can’t rise any further. “It’s more likely we’ll see the second before we see the first,” he says.
Tags: forex, Rob Booker, TICs data, U.S. dollar
