Hey John!! Yeah.. wondering what's going to take the dollar down as well.. IMO, it will occur when the markets perceive velocity is beginning to return and the markets fear that the Fed won't drain liquidity as fast as they've added it.
Btw.. not a big fan of George Soros on the political front, but one has to acknowledge his insight into financial markets. He has some VERY interesting comments about CDS markets and how they have contributed to this mess by contradicting the "efficient markets theory". Particularly interesting is his discussion (in Bold) of how risk/reward differs between equities and CDS markets:
First, there is an asymmetry in the risk/reward ratio between being long or short in the stock market. (Being long means owning a stock, being short means selling a stock one does not own.) Being long has unlimited potential on the upside but limited exposure on the downside. Being short is the reverse. The asymmetry manifests itself in the following way: losing on a long position reduces one’s risk exposure while losing on a short position increases it. As a result, one can be more patient being long and wrong than being short and wrong. The asymmetry serves to discourage the short-selling of stocks.
The second step is to understand credit default swaps and to recognise that the CDS market offers a convenient way of shorting bonds. In that market the asymmetry in risk/reward works in the opposite way to stocks. Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential; by contrast, selling credit default swaps offers limited profits but practically unlimited risks.
The asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds. When an adverse development is expected, the negative effect can become overwhelming because CDS tend to be priced as warrants, not as options: people buy them not because they expect an eventual default but because they expect the CDS to appreciate during the lifetime of the contract.
No arbitrage can correct the mispricing. That can be clearly seen in US and UK government bonds, whose actual price is much higher than that implied by CDS. These asymmetries are difficult to reconcile with the efficient market hypothesis, the notion that securities prices accurately reflect all known information.
The third step is to recognise reflexivity – that is to say, the mispricing of financial instruments can affect the fundamentals that market prices are supposed to reflect. Nowhere is this phenomenon more pronounced than in the case of financial institutions, whose ability to do business is dependent on confidence and trust. That means that “bear raids” to drive down the share prices of these institutions can be self-validating. That is in direct contradiction to the efficient market hypothesis.
ft.com
So.. in sum.. we know that going long on a CDS is equivalent to shorting the underlying bond. And we know that the loss in that CDS that can be realized is finite- 100% of invested capital (as opposed to shorting where loss is infinite).
My friend, Soros has given me a different way of perceiving the threat of the CDS markets (probably something you already understood). Effectively, shorting CDS's (which would be the bet if global bond markets are to strengthen) is a higher risk proposition, equivalent to shorting a stock. It's just easier to bet against global debt markets by buying the CDS and holding them as a warrant.
Also.. Soros' comments related to AIG and CDS markets:
Putting these three considerations together leads to the conclusion that Lehman, AIG and other financial institutions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other. Unlimited shorting was made possible by the 2007 abolition of the uptick rule (which hindered bear raids by allowing short-selling only when prices were rising). The unlimited selling of bonds was facilitated by the CDS market. Together, the two made a lethal combination.
That is what AIG, one of the most successful insurance companies in the world, failed to understand. Its business was selling insurance and, when it saw a seriously mispriced risk, it went to town insuring it, in the belief that diversifying risk reduces it. It expected to make a fortune in the long run but it was destroyed in short order.
What say you?
Hawk |
