End of the road for the dollar?

March 25, 2009 — Mitul Kotecha

The comments by China’s central bank governor  about the US dollar have provoked much speculation ahead of next week’s G20 meeting in London about the potential for the world’s biggest reserves holder (around $2 trillion) to shift away from dollars. The idea of China’s central bank governor is to use SDRs as an alternative to the US dollar. China’s concerns focus on the risks of a big increase in inflation in the wake of the Fed’s plan to move to full blown quantitative easing by buying US Treasuries as well as the massive blowout in the US budget deficit. This would hit the value of China’s massive (over $700 billion) holdings of US Treasuries.

Don’t get too excited though. The likelihood of any change in the use of the dollar as a reserve currency is extremely limited. Using the SDR would itself involve many technical issues in terms of how much to issue and whether companies and investors would accept the use of SDRs rather than dollars. Such a move would take years. The reality is that the risks to the dollar have clearly risen and the crisis and money printing by the Fed has fuelled significant risks over the medium term, to foreign holders of US debt such as China. Nonetheless, there is no other currency that is in a position to displace it at the moment and possibly for several years. Eventually the use of the euro and even the Chinese yuan may reach a point when they share the status of reserve currency with the dollar, but this is not going to happen anytime soon. In other words there is no need to go get rid of your Greenbacks just yet.

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Running out of steam

March 25, 2009 — Mitul Kotecha

The euphoria in markets over recent days appears to be fading but only after a fairly solid rally in equities amounting to around 20% in some stock indices from their lows. Financials have led the gains over recent weeks helped more recently by a warm reception to US Treasury Secretary Geithner’s plans to fix banks.

Although I am doubtful about the staying power of the recent improvement in market sentiment I have to admit that there are clearly positive steps in action in the US both from the Fed and the US Treasury.  In fact the US authorites have gone all out to get things turned round.  This appears to have put a floor under risk appetite for now. 

Ok there are still a lot of questions to be asked such as how quickly the Geithner’s bank plan will work or whether banks will be unwilling to offload toxic debt at a significant loss or whether the deal is a raw one for US tax payers who seem to be bearing most of the downside and not too much upside if things go well.  All of that aside something is better than nothing even with its faults.

As for equity markets this still smells like a bear market rally or put another way a dead cat bounce.   I could be wrong and will be happily eat my words but I can’t see how the rally can be justified given the struggle ahead for both banks and the economy.   At best, what to expect is a period of high volatility before a real recovery arrives. 

Posted in equity markets, Financial crisis, US, US administration. Tags: , , , , . Leave a Comment »

Fed throwing everything but the kitchen sink at the crisis

March 20, 2009 — Mitul Kotecha

The aftermath of the Fed’s surprise decision to buy US Treasuries was dramatic across markets, with Treasury yields dropping, equities rallying and the dollar sliding. The Fed has now moved from what was initially credit easing to full blown quantitative easing. Effectively the Fed is throwing everything but the kitchen sink at the problem and is arguably the most aggressive central bank at present.

What are the implications:

1) Equities like the news and it helped extend a rally that had been in effect for a couple of weeks. But the momentum is likely to run out quickly as the bad news starts to filter back into the market once again.

2) Commodity prices rallied, especially gold. Why? Inflation concerns intensified following the Fed move due to the risk that the Fed will not be able to end it’s programme of “printing money” quickly once the economy starts to turn around. Commodities are set to rally further.

3) The dollar dropped like a stone, and although it is difficult to see it regaining much ground in the wake of a central bank that flushing the market with dollars, its falls looks overdone. For now, the dollar looks like it has entered new weaker currencies and may even benefit if the market appetite for risk declines again.

4) Other central banks in particular the European central bank will be under huge pressure to follow the Fed. The Bank of England, Bank of Japan and Swiss National Bank have already moved but not as aggressively as the Fed. So far the ECB has been reluctant to act and technical issues mean that it can’t act in the same way as the Fed. Nonetheless, the rise in the euro means that something may need to be done and quickly.

5) The move by the Fed shows that policy makers are doing all they can to turn things around, but this is merely a reflection of the severity of the crisis. Economic recovery is still some months away

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Dead cat bounce or real recovery?

March 14, 2009 — Mitul Kotecha

Over recent days the market has been acting as if a bottom has finally been reached. Data releases such as the surge in US housing starts and other less negative economic numbers have helped. More importantly, some banks have noted that they have had a strong start to the year, which will come as a relief to many bank shareholders who have seen their holdings disintegrate over recent months. Along with the improvement in risk appetite the US dollar has weakened as the repatriation of US money from overseas has slowed and the safe haven bid for Treasuries has pulled back.

How long will it last? Not long in my view. Markets have been heavily sold and some form of recovery had to happen but it will not be sustained and is more like a dead cat bounce than a market turnaround. The economic news will remain bad and if anything will get a lot worse in the weeks and months to come whilst banks remain heavily burdened with toxic debt. Moreover, the issue of how to value this debt remains a problem in that it is a key obstacle to removing such debt. Indeed, the US and global economy for that matter will not stabilise until the end of this year. The next problem for banks will be consumer debt and credit card defaults etc even if other toxic debt is removed.

So, I would suggest not getting too excited by this market as the potential for disappointment is very high. As for the dollar, it is getting hit but not dramatically and as risk aversion picks up once again, the dollar will find itself back in command.

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