US Dollar Bears

Let me reiterate my view that the dollar will weaken further and I would not be surprised to see the euro to breach 1.45 level. The aggressive quantitative easing in the US with the Fed’s balance sheet potentially doubling in size will be the key argument to support my arguments. Also is the fact that the return of risk appetite is positive for Euro now, as indicated by the tight correlation between the S&P 500 and Euro. The Yen weakened during the BoJ quantitative easing period in Mar 2001 to Mar 2006 even with a current account surplus of more than 3% of GDP.

Having said that, I am doubtful that the dollar will lose its reserve currency status. Clearly, this is an issue after China’s central bank Governor Zhou Xiaochuan called for the creation of a new non-sovereign official reserve currency. The IMF’s Special Drawing Right (SDR) could be a potential candidate to replace the dollar, but the lack of investible assets denominated in SDR makes this currency not as competitive against the USD and the Euro.

Private sector risk aversion and the tightening of lending conditions will, at times, overwhelm the Fed’s efforts. What’s more, the current situation shares eerie similarities with Latin America’s petrodollar crisis in the 1980s, which then get us to years of hyperinflation and sharp volatility.

Industrial commodities, which are having an inverse relation to US dollar, are bouncing off their bottoms and headed higher. Simply put, the Fed has cranked up the printing presses and the CRB index has pushed above overhead resistance and its 50-day moving average.

For the first time in history, US banks have suffered large, ominous losses and according to the fourth quarter report just released by the Comptroller of the Currency (OCC), commercial banks lost a record $3.4 billion in interest rate derivatives or more than seven times their worst previous quarterly loss in that category. Considering their far larger volume, any threat to interest rate derivatives could be far more serious than anything we have seen so far. Meanwhile, time bombs continue to explode in the credit default swaps as well, delivering another massive loss of nearly $9billion.

For now, the dollar stays under appreciation pressure from continued global de-leveraging and a global bid for scarce dollars to fund USD denominated assets. Having said that, I think it will be several months yet before the tide on the USD turning.