The Buck Stops Where?

Alternate title: The  Buck Flops Here.

A few weeks ago, when discussing my Bearish 2nd half outlook, a guest on Kudlow said  "That could only happen of the dollar really gets killed." I answered that a dollar collapse was only one risk factor facing markets at this phase; clearly, its an important issue for how markets will perform. 

Today, the WSJ reports "The dollar is suffering its most painful selloff in months, a trend that could reverberate throughout the stock and bond markets."

As Oil spiked and Gold rallied (or is it the other way around?) U.S. currency fell to an 11-month low versus the euro Friday. Its also at a two-decade low against the Canadian dollar. Last week’s drop was the biggest decline in 4 months.

History reveals that as soon a sthe Fed stops, equity Markets rally a few percent, while the dollar sells off hard. The Pause/Resume scenario Bernanke hinted at last week is certainly a motivating force for last week’s dollar daze.

The WSJ reports:

Analysts say the biggest beneficiaries of further dollar declines this year are likely to be the yen and other Asian currencies, some of which have been rallying since the fall. The Korean won, for instance, has soared 11% against the dollar over the past six months and is back to levels not seen since the 1997 currency crisis. The yen rose to 113.86 yen last week versus the dollar, a six-month high.

The dollar already was going through a rough patch when it was hit on two fronts last week. The Group of Seven leading industrial nations said emerging economies should let their currencies appreciate to help reduce the large trade surpluses these countries have with the U.S. and other developed nations. Analysts say the G-7 statement represents a step forward from Washington’s lone voice and ratchets up the pressure on Asian governments to allow their currencies to appreciate.

Federal Reserve Chairman Ben Bernanke, testifying before Congress on Thursday, offered the strongest indications yet that the central bank might be about to pause after a long period of interest-rate increases. For traders already inclined to sell the dollar, "this was like waving a red flag in front of a bull," says Adnan Akant, a managing director at New York money manager Fischer Francis Trees & Watts.

A falling dollar could mean bad news for the bond market because it can lead to inflation and higher interest rates. While a weaker currency is beneficial for some stocks because it makes their products overseas more competitive, many companies also would face higher costs on goods from abroad."

Things to watch for are weakening consumer staples (Wal-Mart), slowing foreign  capital flows into US investments, a new challenge for Asian exporters (Sony, Toyota). Its a negative for Bonds, as a weak currency is inflationary, and yield will have to rise proportionately to attract overseas investors and make up for thier currency risk. I would expect banks to be problematic also.

On the strong side: Material and energy sectors (Oil & Gold) US exporters and industrial manufacturers  (Boeing, General Electric, Caterpillar and John Deere), Tourism and Travel to the US gets that much more attractive to Europeans and Asians.

Should be interesting, to say the least . . .


Dollar’s Slide Could Roil Stocks
WSJ, May 1, 2006; Page C1

What's been said:

Discussions found on the web:
  1. B commented on May 1

    This is an article that is a prime example of a reporter not having a firm grasp of economics as Ned pointed out yesterday. Or, to be fair, at least not reporting as such. The article is partially useful in reporting the fact the dollar has been dropping. But it appears he looks on his chart and sees a scenario develop and it says buy inflationary or export driven stocks when the dollar is falling. Yet the price appreciation of inflationary input classes are supposedly driven by Asian demand.

    So, if Asian demand for commodities is likely to abate or even fall off of a cliff if their currencies appreciate-because they won’t stimulate their own consumer instead choosing to rely solely on exports to the US-, how is that going to fuel further global inflationary pressures? And, without further stimulus of the non-American consumer, how will it help export driven companies in the US that are really shipping overseas for goods and services to be shipped back to the US? In both instances you can have a set up for a scenario to come to pass. But, for it to actually happen, someone other than the US needs to buy something. And not in the interim step of production on the way to its final destination, the American consumer.

    This scenario will potentially create an period of deflation or stagflation more than it would create a period of inflation. This is the same mentality of the average mutual fund management team. That is why 90% don’t beat their respective index benchmark and 70+% underperform the S&P. If the dollar drops outside of its historical trading bands, we can guesstimate what might happen but we’ll likely see quite a few gophers pop up that we didn’t expect either.

    Something has to give here. Either we have a housing bubble or we don’t. Either we have a tapped out American consumer or we don’t. Either we have the Chinese miracle or we don’t. Either we have a dollar crisis coming or we don’t. Either, either, either.

    If we have all of these negative imbalances, then our end of cycle scenario is not inflation. It’s an asset bubble which will eventually pop. If that happens, we had tremendous intermediate term inflation followed by the end state of asset prices cratering while demand craters simultaneously. It won’t matter how much inventory of copper is in London because no one will want it. Why can’t people see this? That is how every cycle ends. Instead of asset prices being hard assets, most people are used to it being equities. Commodity prices will go up till they break demand. Just like equity cycles. How can these prices go up so high and not affect global demand? People say they are going to the moon. Those were the same people on CNBC saying houses were going to the moon. Or in 2000, stocks were going to the moon. That’s right. They were. Until they shut off demand because they were a self fulfilling prophecy. Markets do work and the Fed doesn’t always need to pop them. They usually do that quite well on their own.

  2. The Nattering Naybob commented on May 1


    I have weighed in on this one at the supplied link:

    Bottom line: The only “way out” is an equilibrium interest rate level which keeps foreigners buying bonds and supporting the dollar, but doesn’t choke off the housing sector or shave too much off its underlying asset values. Is this possible?

    Time will tell if “Goldilock’s” shows up at the door. Personally, I think its “slim and none” and Slim just left town…

  3. commented on May 1

    Opening Bell: 5.1.06

    Immigrants Plan Nationwide Day of Protest (AP) It’s May Day, which, as leftists will repeat to you ad nauseum, isn’t a celebrated holiday in the US, but is in Europe. But there’s nothing like a general strike to get those…

  4. The Everyday Economist commented on May 1

    The Falling Dollar

    The Wall Street Journal reports that the dollar has fallen to an 11-month low. This has sparked worries are higher inflation due to the rising cost of foreign goods due to reduced buying power. However, the fall of the dollar is a prime example of ho…

  5. getshort commented on May 1

    Won’t a lower dollar help prop up our exporters? I would imagine that that would help large caps and the stock market in general.

    Yeah, I know…the large cap rally has been right around the corner for the last 5yrs but eventually those suckers have to go up, no?


  6. Barry Ritholtz commented on May 1

    Yes. That’s why I wrote:

    “On the strong side: Material and energy sectors (Oil & Gold) US exporters and industrial manufacturers (Boeing, General Electric, Caterpillar and John Deere), Tourism and Travel to the US gets that much more attractive to Europeans and Asians.”

    You gotta read to the end of the post . . .

  7. royce commented on May 1

    A lot of the largest caps also do huge business overseas. So wouldn’t the revenue of those operations be reported in dollars and the reported earnings get a boost over here? Or would higher materials costs wipe those gains out?

  8. Brownbear commented on May 1

    Regarding tourism: do you have any idea how hard it is for citizens of most Asian countries to get tourist visas to visit the US? The hurdles to get visas has surely played a role in decreasing tourisom from Asia.

  9. thecynic commented on May 1

    now that the press has jumped on the dollar bearish bandwagon it looks to have finally put in a near term bottom at 85.50 on DXY…
    i think it is interesting that the recent top in DXY was on 11/16 at 92.63, the exact same day Bernanke was approved by the Senate Banking Committee. it’s down 7% since that high and the S&P 500 is up 6.5%.
    if you made 6.5% on your equity investments but lost 7% of purchasing power did you make any money?
    the government is obviously still inflating and now Bernanke is ignoring the market’s warnings. as one trader in Fri’s WSJ put it, “This was the Fed giving a green light” to sell the dollar. Until Bernanke proves he’s willing to defend the currency it will continue to deteriorate and drive interest rates higher.

  10. wcw commented on May 1

    Why would Bernanke defend the dollar? While it’s no longer (imo) dear against the Euro, there’s a reason Japan, China, India and Korea’s central banks have to buy dollars.

    On-topic, one commentator whose work on currencies, wrong though he’s been the last couple years (due to that same asian-central-bank binge) is Brad Setser.

    Off-topic to B: the reason the majority of fund managers underperform is fees. Before fees, your null hypothesis is market performance (since in the aggregate they are the market), and I have not seen any evidence falsifying it. Subtract fees from market performance, and voila, the majority underperforms. It has nothing to do with their “mentality” and everything to do with fees.

  11. B Bernanke commented on May 1

    Hi Barry,

    What are your short term targets for USD vs EURO and Gold in Oz ?

  12. chuck commented on May 2

    For a bit of prospective on all this weak dollar/ inflation talk consider this…
    According to the Treasury Department, America’s first 42 Presidents (from George Washington to Bill Clinton) borrowed a combined total of $1.01 trillion from 1789 to 2000.

    Between 2000 and 2005, President George W. Bush has borrowed $1.05 trillion — and he’s got a few more years left to go.

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