A View from the Trenches, October 7th, 2009: "The fall of the USD"
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Yesterday’s action was in line with our latest comments: The world
is leaving the USD. Nothing else can be affirmed with higher certainty
than this. Everything else is pure speculation. I can think of three
levels to analyze the fall of the USD:
1. - The short term
The fall of the USD necessarily triggers relative price adjustments.
For one, it appears that it got stronger after the “cash” rate increase
announcement by the Reserve Bank of Australia (from 3.00% to 3.25%).
Thus, the first relation that has been adjusted is in the rates market.
The rates differential triggered a steepening of the US benchmark
curve, which may/should drive negative convexity hedging flows in the
mortgage-backed securities space. The other side of a lower USD is what
the market might have interpreted as an export or Main Street friendly
backdrop. Equities had to rise and did rise. Of course, it is nothing
else but the reflection of a weakening currency, a deflator. Lastly, it
was interesting to see that the CDX IG13 index was on a solid widening
trend, while the S&P500 at mid-session was struggling to keep above
1,050pts. In credit thus, shorts won the day, which brings me to my
next level…
2. – The near term
Can we see a recovery in the US driven by the depreciation of its
currency? I am sure that by now there is enough historical evidence to
suggest that depreciating one’s currency leads nowhere. However, before
we reach this conclusion, we may as well ask ourselves whether we can
actually blame the US for this depreciation. In my view, that is the
case. The Fed and/or the Treasury could have communicated a more
convincing story on this matter. Whatever assurances the market
received that the US is better off with a strong USD came from the most
unexpected characters in this play, like the president of the European
Central Bank. Silence on the part of US authorities led to confusion,
and confusion led to deception. Nevertheless, the bottom line here is
that currency depreciations never solve problems. And there are lots of
them, beginning with a high unemployment rate. Currency manipulations
in the global economies of the 21st century, where goods are made of
components manufactured in a diversity of currency areas, represent a
real and tangible distortion in relative prices. The result is the
misallocation of resources, with labor being one of them. The other
important misallocated resource is capital, regardless of whether it is
supplied in the form of debt, hybrids or equity. In the case of capital
supplied via debt, the credit market unanimously spoke up yesterday,
when it saw an opportunity to get net short in investment grade.
Interestingly enough, emerging markets sovereign risk tightened
significantly, reminding me of the sweet ‘70s, which led to the
sovereign defaults of the early ‘80s.
3. - Longer term
The fall of the USD must also be considered as a relevant milestone. It
shows a crack in what was until now a common, united international
front against the financial crisis. Right now, it is of no consequence.
However, as monetary and fiscal policies become less internationally
coordinated, the world loses a tool that is necessary to confront a
future potential increase in bankruptcies. The 2009 refinancing wave
has only shifted default risk a couple of years away. Its success will
depend on the speed and strength of the recovery that we can enjoy
until then.
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