May 12, 2005

Evaluating USD Strength

While the dollar is showing some strength on the smaller than expected trade deficit, I am not convinced it means a whole lot. I still tend to view Asia vs. Europe as the better risk trade but the U.S. is not fixing any of its longer term problems, so it will probably resume its downtrend eventually. The new budget (mentioned here via Brad Setser and here via Mark Thoma) is just adding to capital account needs and over time the trade numbers will reflect these policy mistakes.

Bill Cara explores the dollar's overnight strength and concludes with this:

I say that if the Bank of China does not revalue the Renminbi yuan this weekend, which is a longshot at best, there will be serious hedge fund failures next week. That's because traders like me are massively short the dollar and will have to close those positions.

Financial Armageddon just could be at hand, and we all were looking at the GM equity-bond trade issues as the biggest problem for some hedge funds when we should have been looking at the Dollar.

Traders cover losing bets all the time but hedge fund failures are a bit more infrequent. It is certainly in the air this week but with JPY below 136 to the EUR I am not sure people are that stressed. Below is a EUR/JPY chart with 4 hour bars.

Click on the chart to see a larger image!!
Posted by Hello

That seems like where the renminbi revaluation expectations have been most pronounced and probably where their is the most risk of a snapback. Greenspan's speech swung some weight behind the idea that China was facing internal pressures to revalue and that is a very persuasive argument for macro funds. The U.S. trade deficit doesn't seem like much of a catalyst in the trade. More of a distraction.

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