Friday, August 15, 2008
USD Strength Is Temporary
Don't make the mistake of thinking USD strength is responsible for the collapse in commodity prices. The dollar DID NOT cause the collapse. To think like that would bring about the wrong investing strategy going forward.
There is very little to support a bullish dollar going forward. The connection is reversed, its not a dollar led sell down. Its the deleveraging by index funds and cut-loss by speculators in almost all commodity asset class which has brought about the cashing up. The dollar has been inversely correlated to commodity prices for the past 3 years. Its only natural for the inverse correlation to hold as well.
To many index speculators, to go long on commodities is one trade. If you wanted to enhance returns, you can also short the USD, its a double whammy. Plenty of hedge funds have taken on this strategy, and what we are seeing is the reversal of that. Hence the strength in USD is pretty fake.
Amidst a slowing US economy, the biggest determinant for USD strength would have to be the outlook for higher rates. Fed funds is at 2%. Even though July inflation was at a 7 year high, or was it 13 year high, either way that is expected to come down significantly owing to the sharp drop in oil and other commodity prices since then.
The biggest factor the Fed and the Treasury will be considering when thinking whether to raise rates is the amount of recapitalisation, the amount of mortgage resetting, and the various restructuring that is ongoing to help the smaller and regional banks to survive. Any rate hike would affect the above issues negatively. The Fed and Treasury cannot allow that to happen.
Hence, to me the fed funds rate has almost minimal chance of being hiked for the rest of the year. I see a 60% for it to stay at 2% for the year, and a 40% that it may go lower to 1.75% before the year is over. That being the case, there is very little chance for USD to maintain its rally.
Once the commodity prices flattens out, the USD should continue its slow downside weakness again. We are getting close to those levels, oil should stabilised just below USD110 and CPO's bottom range is around RM2,450-2,500. The proper investing strategy taking that in mind is a refocus on strong emerging markets with strong trade surpluses and foreign exchange reserves.
p/s photo: Onjira Lamwilai