US Dollar Index Technical Analysis

1 year chart of the US Dollar Index, shows some negative divergences alongside a rising trend chanell and a possible intermediate term base forming while gold gets hammered below $880 at the moment. The index may trend up but it may do so on increasingly weaker technicals, making the sustainability of any rally questionable.

My May 24th, 2008 chart of the GLD noted a potential fall back down to support levels below $90, thats happening now due to the recent weakness in crude oil and bounce in the US Dollar. The longer term picture remains unchanged on a technical basis for the US Dollar's down trend.

J

Nouriel Roubini and the US dollar

Nouriel Roubini, on point as always highlighting the inadequcies of the G7 attempts to talk up the US as the ECB faces growing concerns that intervention may be the only hope the Forex market has to return to some sense of normalcy.

What that is in today's markets is anybody's guess.

J




G7 Stance on the US Dollar: Talk is Cheap

Nouriel Roubini Apr 14, 2008


The French Finance Minister Lagarde compared the G7 statement on the US dollar to the 1985 Plaza Accord to weaken the US dollar; but the forex market pretty much ignored the statement pushing the dollar further down. The statement certainly signals that the G7 are getting closer to the point where the dollar weakness bothers both the US and Europe and where coordinated forex intervention may be considered; but as the saying goes “talk is cheap”. Verbal intervention – of the sort used even by Trichet in the last few weeks and used by the G7 in their weekend statement – almost never works (as the Japanese learned a few years ago). Also sterilized fx intervention usually does not work – unless such intervention goes with the wind rather than against the wind, is seriously coordinated and aggressive and signals future changes in actual monetary policies (i.e. unsterilized intervention).

What works in affecting exchange rates is unsterilized intervention – or equivalently – changes in relative monetary policies, i.e. changes in policy rates.

Currency movements are driven – apart from market noise and momentum – by economic fundamentals. Several fundamentals are driving the dollar south relative to euro and other floating currencies.

Lets discuss these fundamentals and their implications…

First, the still large and structural US current account deficits that – however shrinking – is still huge is bearish for the dollar.

Second, relative interest rate differentials; and with the Fed still expected to cut rates while ECB and BoJ are so far on hold this is dollar bearish.

Third, relative growth differentials; and with the US entering a recession while Europe and Japan slowing but at a more moderate rate this is also bearish for the US dollar.

Fourth, the relative riskiness of US assets relative to European and Japanese assets; and with the US financial crisis still in full swing, toxic assets still partly hidden (who is holding them and how much?) and the risks of further writedowns still large this is another bearish factor for the dollar.

Fifth, with China and other effective members of BW2 still effectively heavily managing their currencies relative to the US dollar (or still into outright pegs as in the Gulf states) downward fundamental pressures on the dollar are reflected in the dollar rate relative to the floaters rather than against the Asian and BW2 currencies.

So, all these five fundamental factors imply a weaker dollar ahead relative to the euro and most of the other floaters. So would verbal intervention work to stem the fall of the dollar? Of course not. So, would coordinated sterilized intervention work? Maybe for a few days but not much more.

Would unsterilized intervention or reduction in policy rates in Europe work to stop the ascent of the euro? Yes but an ECB worried about inflation has not yet reached the point of easing Eurozone rates to stem the rise of the euro. So Trichet may express his concerns about a strong Euro – and a euro close to 1.60 relative to the dollar implies pain not only for exports of the PIGS (Portugal, Italy, Greece, Spain) but increasingly also for those of France and of the Germany (the export superpower); but unless he is willing to ease rates the fall of the dollar relative to the Euro may continue for a while.

So, what could stop a disorderly fall of the dollar and a disorderly rise of the euro and the yen? At some point the rise of euro and yen is going to weaken enough economic growth in the Eurozone and in Japan that two things will happen: the growth slowdown in Europe (with outright recession in some European economies) and Japan (with the risk of Japan tipping into another recession) will tip growth rate differentials that are now bearish for the dollar into being bearish for euro and yen. Second, such a growth slowdown in Europe and Japan will lead to expectation if policy rate easing by ECB and BoJ that will also tip interest rate differentials against euro and yen.

Certainly with the euro now closer to 1.60 than 1.50 the euro is overvalued in real terms: European traded goods are much more expensive than American goods (or as European observers put it to me: “for European tourists goods are now cheaper in New York than in Bangkok!”). I.e. on a PPP basis the euro has already overshot upward its fundamental value. But market dynamics, herding and momentum can drive the euro above 1.60 (and possibly the yen back towards 90). But the more this short-run overshooting occurs the weaker the Eurozone and Japanese economies will get and the more likely the probability of ECB and even BoJ cutting rates. Thus, if euro and yen were to overshoot in the short run market forces (relative expected growth and interest rate differentials) will put a floor to how weak the dollar can get and how strong the euro and yen can get.

So, with BW2 central banks still aggressively managing their currencies values relative to the US dollar and the currencies of the floaters being controlled by endogenous changes in relative economic fundamentals a total disorderly crash of the US dollar is unlikely. And given a severe US recession and a global recoupling of growth these limits to further sharp weakness of the US dollar may imply that global imbalances may remain large for the foreseeable future even if the dollar weakness does – at the margin – help the narrowing of the US current account deficit.

In conclusion, Mr. Trichet if you are really worried about the rise of the euro there is something very simple you can do to stem that rise: cut European policy rates! All the rest – including coordinated sterilized intervention – may end up being cheap talk.

Yuan continues rise against the dollar

This aritcle on the Yuan's steady appreciation against the US dollar appeared in yesterday's IHT. Domestic inflation in China is rising steadily, while the it's central bank is being pressured to allow further appreciation. The rising Yuan's effect on the US dollar coulpled with the ECB's recent decision to freeze interest rates portends further weakness for the US dollar.



Dollar falls below 7 yuan for first time since 1993

By Lu JianxinReuters
Thursday, April 10, 2008


SHANGHAI: The dollar weakened and slipped below 7.00 yuan on Thursday for the first time in over a decade, underlining China's growing economic strength and its increasing use of the currency as a policy tool.

The central bank, which tightly controls the foreign exchange market, paved the way for the rise by fixing the yuan's daily mid-point, or reference rate, at a fresh high of 6.9920 before trade began. The yuan opened at 6.9920 against the dollar compared to 7.0017 at Wednesday's close. It was the first trade above 7.00 since China devalued the yuan to 8.7 from 5.8 at the start of 1994, creating a modern foreign exchange market.

"China is now under both international and domestic pressure for the yuan to appreciate at a fast pace," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen. The Chinese central bank tightly controls the market through regulations and indirect intervention, and has limited the pace of yuan appreciation to support growth in China's exports.

But since July 2005, when the yuan was revalued and its peg to the dollar scrapped, its rise against the dollar has gained pace each year, from 2.6 percent in 2005 to 3.4 percent in 2006 and 6.9 percent in 2007. So far this year, it is up 4.5 percent. The acceleration is partly due to the weakness of the dollar in global markets, and to diplomatic pressure by China's major trading partners for faster appreciation to cut the huge Chinese trade surplus.

Last November, the central bank declared for the first time that it would use the exchange rate actively to fight inflation, which hit an 11-year high of 8.7 percent in February this year. That suggests China is gradually shifting toward managing its currency in the same way as developed economies, allowing big swings to cool the economy when it overheats and to stimulate it during slowdowns, analysts said.

"There now appears to be a clear understanding among the top leadership that sticking to a devalued currency is not good for the Chinese economy, including inflation," said a dealer at a top Chinese state-owned bank in Beijing. He declined to be named because he was not authorized to speak publicly to media.

Yuan appreciation has become especially important to restrain inflation since the start of this year as the central bank has partially loosened domestic monetary policy, flooding the money market with funds to ease financing problems at small companies.

Some foreign investment banks speculate that to prevent inflows into China of funds betting on continuous yuan appreciation, authorities may resort to another large, immediate revaluation of the currency.
But Chinese leaders have publicly ruled out such a step, and the onshore foreign exchange market believes it is highly unlikely because of the instability it could cause.

Instead, dealers said yuan appreciation will slow in the second half of this year as inflation eases and the central bank guards the economy against a slowdown in U.S. and global growth. While the strong yuan helps Chinese firms such as airlines and oil importers to reduce their overseas procurement costs, it is already hurting lower-end exporters such as clothing makers.

Reflecting expectations for yuan appreciation to slow later in 2008, one-year appreciation against the dollar implied by offshore forwards has dropped in recent weeks, to 11.2 percent on Thursday from a record 13.8 percent in mid-March.

Onshore dealers generally have predicted the yuan will appreciate 8.5 to 10 percent for all of this year. The yuan's strength is gradually making it an attractive store of value around the region. Yuan bank accounts in Hong Kong are expanding rapidly, and Chinese businessmen and tourists informally exchange the yuan around southeast Asia.

But for the yuan to become a major traded currency on the scale of the dollar or euro, China will need to remove capital controls and allow much greater market volatility- steps which remain many years away, analysts said.

Global Inflation continues

This story from the New York Times continues to on build the food inflation theme from yesterday's post regarding food riots breaking out across the globe.

Asian Inflation Begins to Sting US shoppers - NY Times

By KEITH BRADSHER

April 8th, 2008

BAT TRANG, Vietnam — The free ride for American consumers is ending. For two generations, Americans have imported goods produced ever more cheaply from a succession of low-wage countries — first Japan and Korea, then China, and now increasingly places like Vietnam and India.

But mounting inflation in the developing world, especially Asia, is threatening that arrangement, and not just in China, where rising energy and labor costs have already made exports to the United States more expensive, but in the lower-cost alternatives to China, too.

“Inflation is the major threat to Asian countries,” said Jong-Wha Lee, the head of the Asian Development Bank’s office of regional economic integration. It is also a threat to Western consumers because Asian exporters, even in very poor countries, are passing their rising costs on to customers.

First, developing countries now produce nearly half of all American imports. Second, inflation in these countries is coming at the same time that many of their currencies are rising against the dollar. That puts American consumers in a double bind, paying at least some of producers’ higher costs for making their goods, and higher prices on top of that because the dollar buys less in those countries.

The cost of American imports from less industrialized countries as a group is rising. A Bureau of Labor Statistics index of average prices for imports of manufactured goods from such countries fell gradually through early 2004, but is now rising briskly and was up 5.6 percent in February from the same month last year. That contributes to rising inflation in the United States; in the 12 months through February 2008, the prices of goods for sale in the United States increased by 4 percent, according to the government’s Consumer Price Index.

But so far, Asian exporters have passed along only a portion of their costs. In China, for instance, prices are now rising almost 9 percent a year, triple the pace of a year ago. Workers in the developing world facing higher prices have been increasingly vocal in demanding higher wages, with protests erupting in recent days in Vietnam, Cambodia and Egypt.

At the same time, inflation keeps rising: the Philippines announced that its inflation at the consumer level had doubled in the last five months, showing a 6.4 percent increase in March over the same month a year ago. And weekly inflation at the wholesale level has accelerated in India, reaching an annual rate of 7 percent in the week ended March 22, up from 3.1 percent as recently as last October.

Not long ago, it would have been unlikely for a poor country with high inflation to see its money strengthen in value against the mighty dollar. But the dollar is not quite as mighty as it once was. Large American trade deficits and other problems have weakened its appeal. And there are signs that the dollar could fall further if developing countries’ central banks stopped supporting it, particularly in Asia.

Vietnam’s central bank even had to order the country’s commercial banks late last month to resume buying dollars within the tight range of exchange rates set by the government. Many banks had started betting on dollar depreciation and refusing to accept large sums in dollars, to the point that multinationals and exporters had trouble wiring money into the country to pay their employees’ salaries.

Inflation in Taiwan has started to creep up partly because the government waited until this year to allow the currency, the New Taiwan dollar, to appreciate. Taiwan imports all its oil, and only now is the slightly strengthening New Taiwan dollar starting to hold down the cost for consumers in filling up their gas tanks.

Keeping the dong inexpensive in dollar terms helped Vietnam increase its exports by 24.1 percent last year, but also lured a flood of investment. Bank loans rose more than 50 percent last year, Breeding a real estate frenzy that has not yet abated.

In addition to the weak dollar, economists say that countries like Vietnam, Egypt, China and Brazil are inherently more vulnerable to inflation when, as now, rising prices are led by increasingly expensive commodities.

Soaring food and energy costs have a far greater effect on developing countries like Vietnam, because of their large agricultural and energy-hungry manufacturing sectors, than on industrialized countries, which tend to have larger service sectors than manufacturing sectors.

But many developing countries, led by China and India, have blunted the full impact of inflation so far through a combination of price controls and subsidies, and more countries are joining them — Vietnam has imposed price controls on transportation and gasoline over the past week, for instance.

As businesses figure out ways around price controls, like charging the same while shrinking the quantities in each package, and as the cost of subsidies may become unsustainably high, inflation may worsen.