WASHINGTON, Nov. 10 (UPI) -- Few issues are more important for emerging market investors than the value of the U.S. dollar. A rising dollar can depress the value of overseas stock holdings even as they're rising in their own domestic terms. A falling dollar -- as we've seen for most of this year -- can give foreign equity prices an added boost.
Accordingly, a week ago some emerging market investors, including our Emerging Markets Group firm, began to contemplate hedging against the possibility of a rebound in the U.S. currency, which would protect some of the dollarized gains seen in foreign equities. Other early pieces on dollar long and short opportunities, such as an advisory by Citibank currency guru T.J. Marta, attracted a flurry of interest among currency traders on both sides. As opposed to hedging, many of these players are interested in speculating.
Is there a good long or short play on the U.S. dollar by year's end? As much as "the bottom line" likes to come to a clear decision, we've talked to central bankers around the world, we don't see any gross mis-valuation of the dollar, long or short, at these levels, and over the coming weeks.
The fundamental forces acting on the dollar for the coming months are these:
1. The U.S. economy. This is surging even faster than many investors seem to appreciate, even following this month's release on third quarter gross domestic product and employment gains. Isn't this strength already fully discounted in most markets? Nope. Years of bearishness have built in a resistance to good news, even over-the-top good news. Over a period of 5-6 months, this should mean a stronger dollar.
2. Most important, Treasury Secretary John Snow wants a stronger dollar. In the foreseeable future, though, he wants it to come about as a result of market forces, and-or European rate cuts, rather than a U.S. tightening heading into an election year. (I happen to believe it would help president George W. Bush not hurt him to have the Fed raise the short-term rate by say 1/8 of a point once or twice from January to September, but politicians never think that way.)
We've reported on this a couple of times in the last six months, and so far everything he's done has been consistent with that.
3. Fed Chairman Alan Greenspan is with Snow, which is why the Fed's rhetoric in minutes in recent meetings is so consistent with trying to scare the Europeans into cutting their rates. This has led to some very un-Fed-like behavior, such as talking about "deflation" -- a word the world hasn't heard much from William McChesney Martin to Paul Volcker to Greenspan -- even as the price of gold, platinum, copper, aluminum, oil, and most other commodities are in fact surging. And not merely back to their pre-deflation levels.
Has the Fed changed a world view that has built up institutionally over 25-50 years? Note likely. Thus the Fed's continued cuts into early this year, and the strong rhetoric about not even a 1/8 hike for perhaps a year or more, are an indication that Greenspan and Snow are hand and glove.
4. The Europeans would like to see a dollar rally, especially given that it would make for a rally in dollar-linked currencies such as the renminbi yuan. But they are loath to coordinate or cooperate with U.S. objectives in the present environment. The Eurozone inflation numbers keep coming in above target, making it hard to justify a rate cut in domestic terms, and they don't want the weak dollar to be the justification. As well, there is a hope on dollar rallies like the recent one, and with strong U.S. markets and GDP numbers, that the dollar will rally on its own. Then the ECB doesn't have to help, and can even sell some of U.S. Treasury securities (as the People's Bank of China is also eager to do given the huge purchases it's had to make to keep the peg).
The deep, passionate, visceral loathing of Bush among some European elites is not to be discounted in this drama -- the more so as U.S. and British policies seem to be working, with lower unemployment rates and (now) strong U.S. GDP numbers and financial markets. The last thing the Germans, French, or the EU consensus wants to do is cut rates just in time to help the dollar, spur world growth, and re-elect Bush. This may be cutting off your nose to spite your face," but then, there's a reason why that phrase is a cliche.
5. The Bank of England might have offered some hope for Snow's strategy this week; instead it ticked rates up a tad.
6. The Bank of Japan is more likely than Europe to be willing to give matters a slight helping hand. Japan has recent actual experience with deflation; they still haven't fixed the banking system; the Japanese aren't furious at Bush to the degree that France and Germany loathe him; and they have even more of a stake in terms of their own perceived trade interests, both directly with the U.S. and with the dollar-linked Chinese. The weak dollar means a weak won, clobbering Japanese export competitiveness in many marginal industries in the Japanese view.
7. China, we have thought for more than a year, is the real driver in all this. The weak dollar hurts Europe directly, of course, but also indirectly through the renminbi won. If the dollar is rising against the yen, but stable against the Euro, then the Euro will have risen this year against the yen, dollar, and Chinese won, at a time of low inflation pressures and GDP and employment stagnation. This argues against European rate hikes despite Britain's.
Alan Greenspan, for the first time this week, began talking about a turnaround. Smart players now believe a Fed rate hike could come as early as January, and not later than March or April. But "the bottom line" is waiting for more such rhetoric, from other Fed governors, before thinking that the dollar's weakness has had it's last leg.
The most important thing to remember in currency trading is that one are dealing with, essentially, a series of monopolists, namely the central banks. This is why there's such an opportunity for sudden crashes and surges when the monopolists get outplayed, a la George Soros with the Bank of England. But they are monopolists, and monopolist pricing and business practices often do not follow a strict "market" style of behavior -- if there's a monopoly, by definition, there isn't a market, there's a monopoly.
Here -- that is, with the central banks -- we have monopolists with political objectives, which means their behavior is not nessarily that of an investor trying to maximize profits. Indeed, the opposite is the case. The central banks tend to "lean against the wind," buying dollars if they're afraid its going down, and selling them to prevent its going up too much. It's almost a "buy high, sell low" model.
Most of the good currency trading benefits from "inside information" -- the eminently legal and moral kind that results when market actors are able to develop a take on what capricious government monopolists are likely to do.
In the meantime, over the coming weeks, we like the dollar best against the yen, and least against the pound and against commodities, with the Euro somewhere in the middle. We're short U.S. debt figuring one will never catch the exact bottom, but that we've probably already hit it, and rates are up from here, sometime.
You don't have to have a position on everything to make money. You just have to be right on the bulk of the positions you take. For that reason, we're not long or short the dollar -- just "out," and long global equities and commodities. But you can expect a greenback rally in 2004.
TOP LINES: Catching up on some previous positions we've advised...
With the Dow slumping towards 9,600 and the Nasdaq close to 1,850, we advised to buy U.S. equities "with leverage," a position that's going well so far. "The bottom line" is still long....
One year and some 80 percentage points ago, in dollar terms, and in followup mentions since then, we gave our reasons for thinking India would be one of the best emerging markets for 2003. We still think it's good for 2004 as well, but have taken substantial profits. A similar observation applies to the Philippines and Thailand -- we're moving Asian assets into Malaysia and China....
Copper telephone companies have gone down not up since our advisories that the Baby Bells were due for a rebound. We still think it's a good long-run play, but it hasn't been good in the short run....
And, we're still short Brazil and Korea. These have also moved in the wrong direction -- up -- but are significantly underperforming world markets since our initial calls. It's been hard to short anything this year other than Kodak, Microsoft, and Sun, but we're not giving up on those -- or our shorts on the U.S. bond market -- by a long shot.
(Gregory Fossedal is chief investment officer of the Democratic Century Fund, managed by Emerging Markets Group. His firm may hold some of the securities mentioned his articles. These positions and opinions are subject to change without notice, and neither UPI nor EMG assumes any responsibility for investment decisions made by readers. Investors should contact their own professional advisor before making any decisions to buy or sell these or any related securities.)
