Henry you wrote:
It is pretty clear that if there were no concerns about the impact on Asia, the Fed would have tightened already.
I certainly agree. So isn't the Fed placing a bet that if Asia does not slow the US economy they will be playing catch up and have to be more aggressive in the future to make up for their earlier stance?
My analysis on the current situation is that two outcomes are most likely. (Certainly not the only possible outcomes)
One. The US economy, despite the drag from Asia and excess inventories, continues to generate enough growth to put inflationary pressures on the economy, particularly on wages. This would eventually lead to higher interest rates which would, I believe, continue to put the dollar higher (due to greater interest rate differentials). When rates reach the stage that they slow the economy, you would experience a break in the US economy, a sharp decline in interest rates and a large decline in the dollar.
Second. The US economy slows without Federal Reserve tightening. This would result from a decline in inventory investment and a further decline in net exports. When the slowdown reaches the worrisome stage the Fed would ease to the point where the dollar would decline enough to reverse the huge drag the trade deficit was inflicting on the economy.
Either way, I think, the US economy will have to slow. Whether it is by the stern hand of Mr. Greenspan or a softer, gentler landing, I cannot be certain. I do feel relatively confidant however, that when it does slow, we will get a reversal in the US dollar. I remain long the dollar since I do not think this denouement is upon us yet, but I am ready to watch the scene unfold.
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