The IMF meeting has come and gone, and it is no surprise that in the end, nothing was really accomplished. Even the IMF managing director conceded that the language was ineffective in establishing any form of a resolution to the global imbalance problems, while Strauss-Kahn also offered the line of the week after saying that the only obstacle was that no one could come to an agreement. Nevertheless, we do believe there were some bright spots, with G20 members doing a good job of defusing and mitigating fears over a currency war, while at the same time, at least agreeing that some coordinated effort will be required to resolve the current global imbalances. Japanese officials seemed to also walk away with some sense of validation after apparently receiving support for their intervention efforts.
To us it is clear that the problems within the currency universe are less a function of any artificial weakness in the Yuan, and more a product of the latest wave of broad based USD declines. The markets are no longer focused on risk themes, and instead are simply committed to selling the USD at every opportunity. This fact has clearly been reflected through the simultaneous multi-year and record highs in the Yen and Australian Dollar against the buck, despite the fact that these two currencies have more traditionally traded in opposite directions. Investors have been solely focused on the prospects for another round of quantitative easing from the Fed and this has been source for all of the USD weakness. However, at this point, technical studies warn that currencies are overbought against the USD and we believe we could be on the verge of seeing a major correction back in favor of the Greenback.
The fundamental catalyst for such a move is unclear at this point, although it is worth noting that the official implementation of quantitative easing the first time around resulted in a broad based USD rally, with the markets selling currencies on the news after having bought aggressively in anticipation of the monetary accommodation. Therefore, we would not at all be shocked to seem a similar reaction again, with QE2 practically all but priced in, and the greater risk from here for some form of a let down which ultimately should benefit the buck.
As far as US Dollar policy is concerned, we are well aware of the ambiguity, with officials maintaining a strong dollar policy, while at the same time sending an entirely different message through actions which have effectively devalued the single currency. However, we would argue that the Treasury (Fed as well) does in fact recognize the need for a strong USD, and is well aware of the risks to any extended declines in the currency (ie Japan). But right now, the US needs to fix the immediate threats to the economy, and with this, comes a policy that unfortunately puts pressure on the USD. We do not buy into the argument that a weaker Dollar will help the economy in the long run, and simply feel that a weaker Dollar at present is merely a by-product of the need for the Fed to be ultra-accommodative. In the end, we are confident that these issues will resolve themselves as we believe that it is in the best interests of the global economy to see a stronger USD. As much as we hear and read of USD diversification, there is still no viable alternative to the Greenback at present.
Looking ahead, the markets should continue to trade off of the broader global macro themes and developments, although with many markets lightened up for holidays (Japan, US, Canada), it is probably best to wait until Tuesday’s more fuller session to make any trading decisions. The North American economic calendar is empty, and most of the attention will be on the official circuit where, Fed Dudley speaks at 12:00GMT, followed by ECB President Trichet at 16:00GMY, and Fed Yellen capping things off at 18:45GMT. US equity futures point to a mildly higher open, while on the commodity front, oil is bid, while gold trades flat.
Written by Joel Kruger, Technical Currency Strategist
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