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On ROB-TV, John Embry discusses central bank manipulation of markets
By Steven C. Johnson
Reuters
Tuesday, June 12, 2006
http://today.reuters.com/news/newsArticle.aspx?
type=reutersEdge&storyID=2006-06-
13T135911Z_01_L13168794_RTRUKOC_0_US-DOLLAR-GAINS-ANALYSIS.xml
NEW YORK -- Global investors' sudden allergy to risk is proving a
boon for the U.S. currency, as money managers sell stocks,
commodities and emerging-market assets and park the proceeds in
dollars.
But this may be more a scramble for liquidity than a genuine safe-
haven bid, analysts said, pointing out that dark clouds still lurk
on the dollar's horizon. And, if the broad downtrend that the dollar
began earlier this year resumes, holders of U.S. assets may face
heavy losses.
Last week, the greenback put in its best performance against a
basket of major currencies in more than a year. On Tuesday, it hit a
fresh one-month high against the euro.
Yet what at first blush looks like a vote of confidence may have
more to do with investor positioning.
"I wouldn't call this a flight to quality -- I'd call it a flight to
liquidity," said Shaun Osborne, chief currency strategist at Scotia
Capital in Toronto.
Indeed, analysts at Barclays Capital found the euro-dollar exchange
rate showed little correlation in the past six years to a risk index
that comprised several key risk meters.
The index included 52-week moving averages of the Chicago Board of
Trade's volatility index, a key gauge of U.S. stock investors'
fears, and the spread between yields on emerging market and U.S.
Treasury debt, which generally measures investor appetite for
riskier investments.
Michael Cheah, a portfolio manager at AIG SunAmerica Asset
Management in Jersey City, New Jersey, said markets in recent weeks
have witnessed the first leg of a two-part process.
"The first part is to unwind trades in emerging markets and
elsewhere, most of which were against the dollar," he said.
Currency analysts at Deutsche Bank said on Monday that their latest
market-positioning indicators showed short-dollar positions -- bets
on a further dollar slide -- were trimmed by a third, while bets on
the euro to rise were halved.
Even more revealing, J.P. Morgan analysts noted that long positions
on Mexican pesos went from being two times higher than last year's
average in April to 3.5 times lower by the end of last week -- a
clear sign investors are shunning risk.
But once traders have bought back dollars, the question, Cheah said,
becomes "what to do next?"
For many, that may not include staying heavily exposed to dollars
for long, as "there are very evident risks out there for the
dollar," Osborne said.
Key among them is the unraveling of the happy confluence of a
steadily rising interest rate, tame inflation and solid economic
growth that buoyed the dollar in 2005.
While the Federal Reserve is still signaling rate hikes to come, it
seems now to be chasing inflation just as growth is showing signs of
cooling. Historically, that's been bad for the dollar.
"Late-stage interest-rate hikes tend to hurt a currency, not help
it, because the economy turns over and people begin to discount
future Fed rate cuts," said David Gilmore, an economist and partner
at Foreign Exchange Analytics in Essex, Connecticut. "That's where I
think we'll end up."
The only saving grace for the greenback may be the lack of safe-
haven alternatives -- and that hardly amounts to a resounding vote
of confidence in the currency.
The most attractive safe-haven currencies tend to be from countries
running current-account surpluses. That, said Bernard Connolly,
global strategist at Banque AIG in London, rules out the most liquid
dollar alternative: the euro.
A mismatch of competitive and noncompetitive economies, the 12-
country euro zone also includes retrograde governments which run
huge current-account deficits of their own.
The Swiss franc, the usual place to park money in times of risk, is
a better bet -- but a much smaller market.
"It may not be possible to find a safe-haven currency that's big
enough for everyone," Connolly said.
Another drag on the dollar is the U.S. current-account deficit --
the broadest measure of trade and investment flows -- which has
ballooned to 7 percent of gross domestic product.
The ideal scenario calls for a slow, gentle dollar slide that
gradually chips away at U.S. deficits, increases the U.S. savings
rate and makes American exports more competitive.
The dollar was oversold amid the recent "liquidity flood" that
supported emerging markets, so further unwinding of those trades may
buoy the greenback for a while, said T.J. Marta, senior currency
strategist at RBC Capital Markets in New York.
But longer term, "reserve banks will eventually diversify holdings,
and that's going to take the dollar lower," he said.
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