A Forex View From Afar

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Usd supports new debt at a cost

Written by A Forex View From Afar on Monday, September 22, 2008

The plan announced by Treasury Secretary Mr. Paulson, to buy $700 billion of bad assets (said to be illiquid) and another $400 billion to guarantee money-market mutual funds raises some question marks as to whether the dollar current valuation will be able to support such debt. In order to get the required funding to make the plan work, about $1 trillion, the Government will have to issue a new wave of debt. Such a massive sale will certainly add additional pressure to the Treasury yields, especially on the short-terms. Yields, in a very straightforward form are the cost of owning money. A lower yield equals a cheap currency; a higher yield denotes a strong currency.

U.S. yields are the second lowest in the industrialized world, only the Japanese yields being lower. Thus, a foreigner holding a dollar denominated bond would mean having to pay negative swap because of the high yield differential. Furthermore, the highly inflationary policy used now by the Fed adds even more downward pressure on the U.S. yields. The spread between the Fed Funds and the inflation rate, measured by the CPI, is now 3.4% the lowest since the 1980’s.

All this put together raises some questions as to whether the dollar does not need a re-valuation, again. On the daily charts, the dollar had already topped against the major currencies on very strong volume, suggesting the greenback will need a lot more momentum to break anywhere higher through the 80.00 dollar index resistance levels. Moreover, the major pairs bottomed when lower yields where not even in sight.

There may however be some light at the end of the dollar tunnel, it seems. As the global slowdown progress, reverse flux from emerging countries will soon start to appear, selling risky “emerging-assets” and heading towards the safety of the U.S. treasuries, (the very ones that pay a negative rate at the end of the month).

To draw a quick conclusion, the outlook for the dollar in the short to medium term lies to the downside, particularly until the Senate comes with a clear and concise text over the bail-out plan. Do not exclude a test of the 74-75 area on the dollar index over the coming period, until the market signals that they are buying into the noise coming from the ticker-tape parade. This took many years of relentless feeding on leveraged debt, there really is no easy, nor instant fix.

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Fundies and Trading
There is a constant question from some traders as to why anybody would ever need to consider the ‘F’ word when trading. Fundamentals: what is so damaging at looking at both Technical charts and having a Fundamental filter to gauge how many Lots to put on? Why is it that accepting that Technicals give us price points to trade, but Fundamentals determine the direction that we travel is so difficult for some traders to accept? Without a Fundamental Filter very few pure Technical traders would have seen this Dollar move coming today.

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