Arch, excellent points - all of which complicate analysis.
The number of interdependent factors bearing on this issue makes my head hurt. FWIW, my take on USD strength/weakness is that contrary to many predictions last year, USD has held up surprisingly well. I attribute that to a mix of factors:
1 - "Safe haven" status - yes, the US economy is bad, but look at the others.
2 - A run on the USD will probably trigger a global collapse, where trillions in USD reserves held by others are suddenly devalued. Thus it's in no one's interest to initiate a run.
--- "Nobody moves, nobody gets hurt"
3 - You are correct that foreign holders of US debt have switched from long-term paper to short-term and dollars. While this is clearly cautionary on long-term prospects for the US economy, it's also short-term supportive.
4 - The major threat to USD strength (in my opinion only) is inflows: nobody knows how long they can be maintained. If they dry up - if there are no more buyers for US debt or dollars - that might precipitate a crisis, and a run on the dollar. There appears to be a calculated risk here: a gamble that the US can continue to borrow until it turns around, while simultaneously instituting massive structural changes that reverse outflows and begin paying down debt.
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"Yet I partially wonder if a weaker currency is one of the desired outcomes of quantitative easing."
I've wondered about that, too. It's clearly inflationary, yet the Fed has steadfastly maintained that it will begin withdrawing liquidity when inflation begins to creep in. But at what level? 10%? Or ~20%, as in the early 80's?
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Some other factors: I think crude is seen as an inflation hedge by some - but if crude drops back to $30 for an extended period of time, that's an expensive hedge.
Finally - talking about hedges - massive hedging on crude will in itself tend to push up spot prices, which will "reflect" up the futures chain. There's evidence to indicate that hedging (by producers and users) has been extensive.
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For better or worse, I think the old demand-supply linkages to price have been broken. Hedging has displaced pricing in time, and results now have different elasticities built in.
As a small fry, the thing that scares me most is the possibility that players taking huge positions may do an about-face, causing big price drops and volatility. These days big players are making dispersion trades that are practically invisible, but have large effects:
"Dispersion traders can come into a single stock and sometimes sell signifcant vegas (read: millions) before anyone knows what is happening."
nuclearphynance.com
Other quant techniques use dispersion techniques in whole sectors.
That's what I think is happening here; based on fundamentals, I'm waiting for someone to pull the rug out. I just don't trust what I'm seeing.
FWIW,
Jim
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