February 06, 2004

Dollar Going No Bid?

Let's look at the dollar and debt in terms of supply and demand. First, to pay for its record deficit, the Federal government plans to borrow $177 billion in the first quarter by selling bonds. It will sell (assuming there are buyers) $24 billion of three-year notes, $16 billion of five-year notes and $16 billion of 10-year notes. From the LA Times..."It's unprecedented this much supply is coming into the market — obviously that's got to get placed somewhere," said Andrew Lombara, a trader at HSBC Securities in New York. Yes. It's got to get placed somewhere. But where? Surely there will be buyers. Even when the underlying currency is falling and U.S. yields are getting even punier compared to yields in Europe, the U.K., and Australia, right? Bloomberg reports that The dollar fell to $1.2601 against the euro at 7:05 a.m. in New York from $1.2535 late yesterday. The dollar, much to my euro-spending chagrin, fell 29% against the euro in the two years to Dec. 31. The Bloomberg article goes on, "We see plenty of reasons for continued dollar weakness,'' said Trevor Dinmore, a currency strategist at Deutsche Bank AG in London. ``Because of the event risk, you don't want to be adding'' dollars before the G-7 meeting, he said. About the only people in the world who seem to want to "add dollars" are the politicians in Washington, by spending more. But you can't keep adding supply, debasing the currency, and expect demand to remain robust. By the way, the BEDspread, my measure of the appetite for U.S. debt versus emerging market debt, stands at 4.65. The yield on a basket of Uncle Sam's debt (GVT) rose yesterday as bond prices fell. It stands at 4.49%. And even though emerging market bonds have fallen recently on a wave of profit taking, yields are hovering above 9%, with EMD, the Salomon Brothers Emerging Market Bond Index, yielding 9.14%. BEDspread watchers know by now what to look for...EMD yields under 9% and a sudden spike in GVT yields above 5%. For now, U.S. bonds are getting a bid at almost any price. And if stocks are weak (on labor news for example), bond yields may fall even more. Don't blink, though. The G-7 meeting is coming soon. And currency markets, as George Soros has said, are panic markets. They do not work in an orderly fashion. "Flexible" currency markets, the kind John Snow has been cheering for, reflect the strength of the underlying economy. If that's truly the case, the dollar's next "adjustment" could be swift and sudden.


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