Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: Skywatcher who wrote (26834)	2/20/2005 10:53:09 PM
From: russwinter	Respond to of 110194

Dollar Forces Continued Rate Hikes Despite Contained Inflation By Kathy Lien, Chief Strategist Published: January 25, 2005 Over the past two weeks, there have been a significant amount of comments from Federal Reserve Presidents on the state and outlook for the US economy, monetary policy and inflation pressures. Both consumer prices and producer prices fell during the month of December. FOMC members have been using this opportunity before the "quiet period" ahead of the February 2nd monetary policy meeting to give the market a look into the possible changes to the FOMC statement. In a nutshell, although inflation pressures remain "contained," the outlook for the US economy is positive and the Fed could very well move to a more aggressive monetary policy over the next few months, depending on the movement in the dollar. Pace of Rate Hikes Dependent on Dollar Regardless of the Fed's cautionary comments on inflation, rate hikes will need to continue at either a steady or aggressive pace to attract capital back into the US. However a steady or aggressive pace could very well be determined by the fluctuations in the dollar. Currency movements, particularly that of the US dollar will play a major role in monetary policy decisions this year. The trade deficit soared to a record high in the month of November. Although the Treasury reported that foreign inflows were more than sufficient to cover that month's deficit, the data was rather distorting. November has historically been a strong month for portfolio flows. The current influx of foreign investments is only $7.3 billion higher than was reported in November 2003. Yet, the trade deficit is $20 billion higher for the same benchmark period. This means that over the medium term, the dollar either needs to continue to depreciate in order to fix the imbalances and force US consumers to import less or the Fed needs to increase the attractiveness of the dollar by raising rates and returning the dollar to its high yielding status. The latter option is certainly more beneficial for the global economy because a contraction in US imports will have widespread negative ramifications for global growth, especially for countries that are heavily dependent on exports. Rate Hikes Needed For Dollar To Continue Rivaling Euro As A Reserve Currency With the euro gaining attractiveness as an alternative reserve currency, many Asian central banks have been looking to diversify their reserve exposure. More specifically, over the past few months, Japan has either been a net seller or only a modest buyer of US Treasuries. European government bonds on the other hand are receiving a significant amount of attention from central banks around the world. Part of the reason why is because although yields in the US are higher than that of the Eurozone, the decline in the dollar is eroding the face value of the investments made by central banks, possibly even negating returns made on yield. As a result, the US needs to change the market's perception of the dollar or risk facing a dollar collapse. In order to do this, the Fed not only needs to raise rates, but also needs to engrain into the market the mentality that rates are on the rise and will continue to be for some time. They have already begun to do this by signaling their intention to bring rates back to what is considered a neutral level that does not increase inflation or spur growth. This is estimated to be anywhere between 3.5 to 4%. If this is the case, then we expect to see at least another 125 to 175bp of rate hikes. All Eyes Will Continue To Be On The Dollar At this point the entire market is watching the dollar. As we have mentioned in previous pieces, the decline in the dollar and the rise in the euro has become "water cooler" talk with widespread coverage by both financial and non-financial publications. We have seen its movements have residual impacts on the equity and bond markets in both the US and abroad. Although the dollar has retraced somewhat since the beginning of the year, there are many traders in the markets that remain convinced that dollar weakness could resume over the next few months. The fall in the dollar during 2004 has hurt exporters in Germany, France, and Japan, just to name a few. Many publicly listed companies such as Volkswagen have reported shortfalls as a result of euro strength. The decline in the dollar also hurts the bond markets by eroding the portfolios of foreign investors who hold dollar denominated assets - it lowers the values of portfolios when they are converted back to foreign currencies. We are already seeing evidence of this. The central banks of Canada and Switzerland left interest rates unchanged at their latest monetary policy meetings because the strength of their currency and weakness in the dollar has taken a significant toll on exports / growth. They too, will continue monitoring their currencies' performance against the dollar to determine their monetary policy biases going forward.