Trees Never Grow to Heaven...
By John R. Taylor, Jr.
...and all oceans have a floor. Ever since 2001, about two months before the World Trade Center and Pentagon attacks, the dollar has been moving generally lower. Between the start of 2002 and March, 2008, the decline was as close to a straight line as any financial market can manage. The dollar dropped 40.24%, falling 48 months out of 75 and only moving up more than 2% on three occasions, one in 2004 and two in the following year. Since March of 2008, the dollar has moved sideways, striking dramatically higher in 2008, but then slipping lower. It is currently slightly less than 10% from its historic lows, as the US Fed has been the leader in expanding global liquidity and has been happy to see the dollar down near these lows. That sure-thing dollar decline was certain to draw a large number of friends. In this case, there were two groups prominent among those who embraced this trend. The first, but less apparent, includes all the major international companies and major banks in every country. With the globalization and growth of the world economy, there is a need for money – the kind of money that can be used everywhere. For instance, if you were a European company building a new plant in Malaysia in 2004, your first choice would probably be to fund the plant in dollars as ringgit would be impossible to get and the dollars were cheap and available, as the US banks and bond markets were very open for business. The dollars you borrowed would be quickly changed into ringgit, spent on local costs at the plant. The major dollar sale, to buy ringgit, would not be reversed for years, if ever, and there certainly was no reason to hedge – or protect against – the risk that the dollar might rise as it seemed as if ringgit would go down forever. Banks are even shorter dollars. If you were running a Thai bank and your deposit base was growing less quickly than the demand for profitable loans, something that happened almost everywhere, you would need to garner global deposits, borrow from another bigger bank, or float a bond. A large portion of those liabilities would be dollars. Borrow dollars, lend baht. Hedging would often be avoided as it cut the profit margin substantially and seemed useless, like throwing money away. While the world economy was growing, this dollar liability grew even faster. Then bang, this large overhang of dollars caused the dramatic dollar reversal in 2008. All of a sudden, no more new loans were made (creating dollar sales) and banks started calling loans (causing dollar purchases), the dollar jumped higher like a lemon pit squeezed between your thumb and forefinger. This crisis saw the dollar jump 25.7% in 6 months; however, Bernanke stepped in, printing money, and the dollar has drifted lower, losing about 8% in 4 years. The other beneficiaries of the weak dollar were US investors, plan sponsors, as well as the reported earnings of US multi-nationals. Since 2000, there has been almost no return from international equities with the currency component removed, as the MSCI unhedged index rose only 0.89% from January 1, 2000 through the end of June, 2013, while the weak dollar, using the trade-weighted broad dollar index, contributed 25.19% to that return, implying that the dollar was the major contributor to that return. Although one could argue that it makes a major difference where the span begins and ends, that is exactly the point. With the dollar near a historic low, the risk of a dollar upmove, and the related currency collapse in the MSCI Index, is significant. From this point, with the dollar so weak, it is very likely that the currency return in the next five years will be more like a mirror image of the past 13 years rather than somewhat similar to it. We would also argue that the US economy is looking very good compared to its G-10 competitors, the US is in the best house on that bad block. Even though the EM markets will most likely out-perform the advanced countries for many years, they have a small weight. As an investor or a plan sponsor, don’t forget that one of the most important components in the success of global investing, ever since 1972, has been the decline in the US dollar. From our point of view, ignoring the value of the dollar is a bad strategy for the years ahead. Global investing needs dollar overlay management.
Things Are Getting Rougher Down Under
by Michael Golik/Joseph Palmisano
The Australian economy has seen a lot of fat years in the past two decades. The Land Down Under hasn’t seen an official recession since 1992 – even during the sharpest throes of the global economic crisis, the Aussie economy was heavily insulated by Chinese demand for the commodities coming out of the robust Australian mining sector. Since the beginning of 2009, the Australian dollar has been the second strongest of the 33 currencies we trade, appreciating by 30.8% versus the US dollar (it was eclipsed only by its neighbor, New Zealand, whose currency grew by 36.5%). However, good times don’t last forever, and Australia has been entering a period of financial turbulence. Slowing Chinese growth has led to a rapid contraction of the Australian mining sector, and Wednesday’s China flash PMI release only indicates more trouble ahead. A greater risk lies in the knock-on effects of this slowdown. We here at FX Concepts put a lot of stock in the theories of Hyman Minsky, who posited that prolonged periods of financial stability lead to the build-up of increasingly unsustainable levels of leverage. As we saw during the US sub-prime crisis, this leverage is capable of magnifying the effects of even a slowdown, leading to a destabilizing wave of defaults and slow-growth period of deleveraging. Australia is flirting dangerously close to the edge of such a crisis. Australia’s four largest banks are currently leveraged at about 24 to 30 times their capital. Also, Australia is in the grips of a housing bubble that has not only seen home prices double in the past 17 years but, more significantly, has seen rapid divergence in average home prices over household income, rents, and construction costs.
The Reserve Bank of Australia (RBA) is no doubt aware of the possibility of such a crisis. It has announced plans to supply its banks with a permanent bailout facility of up to A$380 billion by 2015 and has been fairly dovish about cutting rates in response to the slowdown (even if a rate cut tends to increase easy-times leveraging, the RBA’s rationale is likely that it is forestalling a crisis while putting the appropriate measures into place). The RBA has already stated its inflation outlook provides “scope for further easing”. Wednesday’s release, showing that Australian CPI grew 2.4% in the second quarter from the same quarter a year before is just below the mid-point of the 2-3% inflation tolerance band, and may provide a little more leeway for future cuts. Our cycles call for AUD to fall for several more weeks before an important low is formed. There is a minor low due Thursday and the support at .9120 should be tested. Following an up day Friday AUD/USD will turn lower to early next week, and a close below .9120 will confirm an initial low of .9065 by the end of the week. We expect this decline to persist to the week of August 12 and our target is .8850. This will be the right time for a medium-term low and AUD/USD will then recover for two weeks. Our longer cycles call for the pair to decline to October or November and our further objective is.8400. We expect .9245 to hold, but a close above it means the pair will rally into early September
By John R. Taylor, Jr.
...and all oceans have a floor. Ever since 2001, about two months before the World Trade Center and Pentagon attacks, the dollar has been moving generally lower. Between the start of 2002 and March, 2008, the decline was as close to a straight line as any financial market can manage. The dollar dropped 40.24%, falling 48 months out of 75 and only moving up more than 2% on three occasions, one in 2004 and two in the following year. Since March of 2008, the dollar has moved sideways, striking dramatically higher in 2008, but then slipping lower. It is currently slightly less than 10% from its historic lows, as the US Fed has been the leader in expanding global liquidity and has been happy to see the dollar down near these lows. That sure-thing dollar decline was certain to draw a large number of friends. In this case, there were two groups prominent among those who embraced this trend. The first, but less apparent, includes all the major international companies and major banks in every country. With the globalization and growth of the world economy, there is a need for money – the kind of money that can be used everywhere. For instance, if you were a European company building a new plant in Malaysia in 2004, your first choice would probably be to fund the plant in dollars as ringgit would be impossible to get and the dollars were cheap and available, as the US banks and bond markets were very open for business. The dollars you borrowed would be quickly changed into ringgit, spent on local costs at the plant. The major dollar sale, to buy ringgit, would not be reversed for years, if ever, and there certainly was no reason to hedge – or protect against – the risk that the dollar might rise as it seemed as if ringgit would go down forever. Banks are even shorter dollars. If you were running a Thai bank and your deposit base was growing less quickly than the demand for profitable loans, something that happened almost everywhere, you would need to garner global deposits, borrow from another bigger bank, or float a bond. A large portion of those liabilities would be dollars. Borrow dollars, lend baht. Hedging would often be avoided as it cut the profit margin substantially and seemed useless, like throwing money away. While the world economy was growing, this dollar liability grew even faster. Then bang, this large overhang of dollars caused the dramatic dollar reversal in 2008. All of a sudden, no more new loans were made (creating dollar sales) and banks started calling loans (causing dollar purchases), the dollar jumped higher like a lemon pit squeezed between your thumb and forefinger. This crisis saw the dollar jump 25.7% in 6 months; however, Bernanke stepped in, printing money, and the dollar has drifted lower, losing about 8% in 4 years. The other beneficiaries of the weak dollar were US investors, plan sponsors, as well as the reported earnings of US multi-nationals. Since 2000, there has been almost no return from international equities with the currency component removed, as the MSCI unhedged index rose only 0.89% from January 1, 2000 through the end of June, 2013, while the weak dollar, using the trade-weighted broad dollar index, contributed 25.19% to that return, implying that the dollar was the major contributor to that return. Although one could argue that it makes a major difference where the span begins and ends, that is exactly the point. With the dollar near a historic low, the risk of a dollar upmove, and the related currency collapse in the MSCI Index, is significant. From this point, with the dollar so weak, it is very likely that the currency return in the next five years will be more like a mirror image of the past 13 years rather than somewhat similar to it. We would also argue that the US economy is looking very good compared to its G-10 competitors, the US is in the best house on that bad block. Even though the EM markets will most likely out-perform the advanced countries for many years, they have a small weight. As an investor or a plan sponsor, don’t forget that one of the most important components in the success of global investing, ever since 1972, has been the decline in the US dollar. From our point of view, ignoring the value of the dollar is a bad strategy for the years ahead. Global investing needs dollar overlay management.
Things Are Getting Rougher Down Under
by Michael Golik/Joseph Palmisano
The Australian economy has seen a lot of fat years in the past two decades. The Land Down Under hasn’t seen an official recession since 1992 – even during the sharpest throes of the global economic crisis, the Aussie economy was heavily insulated by Chinese demand for the commodities coming out of the robust Australian mining sector. Since the beginning of 2009, the Australian dollar has been the second strongest of the 33 currencies we trade, appreciating by 30.8% versus the US dollar (it was eclipsed only by its neighbor, New Zealand, whose currency grew by 36.5%). However, good times don’t last forever, and Australia has been entering a period of financial turbulence. Slowing Chinese growth has led to a rapid contraction of the Australian mining sector, and Wednesday’s China flash PMI release only indicates more trouble ahead. A greater risk lies in the knock-on effects of this slowdown. We here at FX Concepts put a lot of stock in the theories of Hyman Minsky, who posited that prolonged periods of financial stability lead to the build-up of increasingly unsustainable levels of leverage. As we saw during the US sub-prime crisis, this leverage is capable of magnifying the effects of even a slowdown, leading to a destabilizing wave of defaults and slow-growth period of deleveraging. Australia is flirting dangerously close to the edge of such a crisis. Australia’s four largest banks are currently leveraged at about 24 to 30 times their capital. Also, Australia is in the grips of a housing bubble that has not only seen home prices double in the past 17 years but, more significantly, has seen rapid divergence in average home prices over household income, rents, and construction costs.
The Reserve Bank of Australia (RBA) is no doubt aware of the possibility of such a crisis. It has announced plans to supply its banks with a permanent bailout facility of up to A$380 billion by 2015 and has been fairly dovish about cutting rates in response to the slowdown (even if a rate cut tends to increase easy-times leveraging, the RBA’s rationale is likely that it is forestalling a crisis while putting the appropriate measures into place). The RBA has already stated its inflation outlook provides “scope for further easing”. Wednesday’s release, showing that Australian CPI grew 2.4% in the second quarter from the same quarter a year before is just below the mid-point of the 2-3% inflation tolerance band, and may provide a little more leeway for future cuts. Our cycles call for AUD to fall for several more weeks before an important low is formed. There is a minor low due Thursday and the support at .9120 should be tested. Following an up day Friday AUD/USD will turn lower to early next week, and a close below .9120 will confirm an initial low of .9065 by the end of the week. We expect this decline to persist to the week of August 12 and our target is .8850. This will be the right time for a medium-term low and AUD/USD will then recover for two weeks. Our longer cycles call for the pair to decline to October or November and our further objective is.8400. We expect .9245 to hold, but a close above it means the pair will rally into early September
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