Is the Dollar Going Down Forever?

Well, to paraphrase Benjamin Franklin, nothing is forever except death and taxes, but it certainly seems that the DGDF crowd is having their day (week? month? quarter?) in the sun.

The normative question of whether the dollar should go down “forever” is an emotive one; Macro Man is generally skeptical of such arguments, particularly in the current context when the US current account deficit (usual source of DGDF $ bearishness) is eminently reasonable by the standards of the past decade or so. Moreover, a number of the currencies that have performed best against the buck recently (here’s lookin’ at you, NZD and ZAR!) haven’t exactly been paragons of balance of payment virtue themselves.

However, while market focus is usually (and justifiably) on the flow of currency movements (i.e., portfolio flow versus the US need to finance an ongoing c/a deficit), it seems as if the current bout of dollar weakness may have more to do with a stock adjustment…i.e., Asian and Middles East CBs reducing the share of dollars in the reserve bounties that they’ve accumulated over the past year or so.

Throw in a step-shift in the perceived equilibrium level of USD/JPY, thanks to DPJ laissez-faire, add a dash of flow recycling from Asian CBs standing in the way of overdue currency appreciation (so what else is new?) , and throw in a pinch of dollar-negative seasonality, and these are the things of which market trends are made.

EUR/USD has broken up to new highs for the year, courtesy of both public and private-sector flow. Near-term resistance lies at last December’s high of 1.4719 and the Sep ’08 high of 1.4866; above those levels, there’s quite a bit of fresh air.

The breakout was confirmed, or indeed foreshadowed, by therally in precious metals a few weeks ago. Gold is not far below its nominal high of 1032 (though obviously well below its real high), but there appears to be more near-term upside in silver, which has broken and held the key $16 level.

There are still a few holes in the DGDF story, however, particularly if it’s one predicated on a cyclical rebound. Base metals have been taken to the smelter recently (boom, boom), whereas one might reasonably expect the rising tide of a broad-based DGDF-deval to lift all boats…even those made of base metals. The chart of aluminum is indicative of the complex.

Similarly, oil (as measured by CLZ9) is off its recent lows, but doesn’t exactly scream “breakout!!!” Now, this may be down to promised OPEC supply, or it may be down to spec limits. But in a world where the dollar truly is “going down forever” and inventories are sharply off their highs (though admittedly above long-run averages), one might reasonably posit that crude would have put in a better show.

So how are we left? Much as it pains Macro Man to say it, it looks like we may well be at the mercy of his old adversaries, the FX reserve managers. Should they continue their recent behavior and consistently buy EUR/USD in the open market, the private sector will happily piggy-back and a trend will be born.

Should they pull the bid and start selling (because as you know, punting someone else’s currency for a percent is a vital part of FX reserve management), well…..then we might find that the dollar going down isn’t forever after all….

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