In late August I put out a warning to clients, colleagues, family and friends — those who I felt may be impacted — that during the month of September the currency markets would experience a VERY BIG MOVE. My logic was based on experience, decades of experience (I won't say how many) in the currency markets, either as a prop (proprietary) trader or advisor. I learned the hard way to tread carefully during every September, to be on guard more so than during any other month of the year.
As it turned out, I was right…and wrong. The currency markets did experience a relatively big move. Most G-20 currencies versus the U.S. dollar in September moved between 5 percent and 10 percent. (Annualize that and you have some very large numbers!) In a typical month we see moves of less than half of that size. Unfortunately — and here was where I was wrong — these currencies all appreciated against the dollar. I was actually expecting the dollar to rally, triggered by a sell-off in the U.S. stock market which never came. In fact, the S&P 500 surged higher by 8.8 percent, the best September since 1939!
Whatever the case, I am not completely giving up on my strong dollar convictions. As a market chartist, I know, for example, that the euro has reached key resistance in the $1.35 - $1.39 range. As a technical analyst, I know from following various market "sentiment" indicators that currency speculators as a group are now excessively bullish/long on the euro (bearish on U.S. dollars), even more so than they were when the euro was trading at $1.5145 back in November 2009, right before the euro collapsed, dropping 22 percent in seven months to a low of 1.1877. My expectations, as a market technician, are that they will be long and wrong.
However, when I put on my "global economist" hat, I start getting nervous about the longer-term prospects for the dollar. I am beginning to feel that the currency game may be changing, and what's changing may be the makeup of the players in the game.
My contacts on the big trading desks are telling me two things. First, central banks, particularly Asian central banks of South Korea, Thailand, Singapore, Malaysia and Indonesia, are selling their respective currencies for dollars in their local markets (aka intervention) nearly every day in order to stem the rise of those currencies. Then, importantly, they have been selling these accumulated dollars for EUR, GBP, JPY and AUD, and even gold. This implies that they may not want any more dollars than they already have. Second, further evidence that the players in the game are changing is that the big FX banks are winding down their prop trading desks. The market impact from fewer bank prop traders may be reduced liquidity in the marketplace, potentially widening bid-offer spreads.
Widespread intervention is changing the landscape of the currency markets and the prospects for the dollar. In addition to the Asian central banks mentioned above, the central banks of Latin American countries — so far Brazil, Colombia, and Peru — are also playing the game. They are intervening to keep their respective currencies from appreciating too much, and not just against the dollar, but against each other.
Japan, as we all know, entered the intervention game on September 15 for the first time in six years by selling roughly $25 billion worth of yen in the open market, driving it down against the dollar by nearly ¥3. The government of Japan has now effectively opened the door for future bouts of intervention in order to preserve or certainly support its feeble export-led economic recovery.
China intervenes every day as a matter of course to manage the value of the yuan versus the dollar. On June 19 it announced they would "gradually make the yuan more flexible," a decision clearly meant to deflect criticism at the summer G-20 summit. Since then, however, the yuan has appreciated by only about 2 percent, much to the chagrin of President Obama who has become increasingly vocal (conveniently ahead of November's mid-term elections) about China's mercantilist behavior. Paul Krugman, Op-ed columnist of the New York Times defines mercantilist as "a policy of keeping a country's currency weak through intervention and capital controls leading to a trade surplus and capital exports; as we know, or should know, this amounts to a beggar-thy-neighbor policy just when the world's major economies are struggling."
The biggest threat to my strong dollar belief is the Federal Reserve's own version of intervention: quantitative easing. In this case, intervention is indirect and in the form of massive U.S. dollar liquidity being pushed into the marketplace. QE1, and now prospects of more liquidity via QE2, has motivated investors and traders worldwide to move out of U.S. dollars and into currencies of countries whose economies are growing and where interest rates are attractive: the emerging market countries. The result, of course, is excess demand for those currencies; hence, the need to intervene by their central banks. What all those central banks do with the dollars they accumulate when intervening may very well determine the NEXT BIG MOVE in the currency markets.
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