After S&P downgraded the debt outlook of the US, the stock market sneezed, drank some high liquidity kool-aid, and then regained a lot of its lost ground. The real interesting phenomenon of course, was in the bond market, where market participants all but ignored the warning from S&P and bought US treasuries for their ‘safety’.
While some people may think this might be due to the damaged credibility of the credit rating agency after the financial tsunami, or that the US’s house of finance is fundamentally strong, the real reason may actually be the strong faith in the bi-winning fed’s determination to destroy the dollar by keeping interests rates artificially low. The evidence is best seen through the currency market.
With all the problems in Euro due to its PIIGS members, the latest being the risk of Greece restructuring its debt, the Euro fell from 1.45/dollar to 1.42/dollar, but then reversed its course and marches steeply towards 1.45/dollar again. Another evidence is on USD/JPY. Japan, with a 200% debt/GDP ratio, and a devastating tsunami that will cause the BOJ to keep its interests rates low for a long period of time, reversed its course of its weakness against the dollar, causing USD to trade below its pre-tsunami level once again. While we don’t believe the JPY can continue its ascend, and that the repatriation of Yen might be at work here, it nonetheless reflects the relative strength of the dollar.
So when will the dollar strengthen again? Long-term wise, it will probably be after the bi-winning fed exits its QEn program, with the likely scenario that n being a double digit number. In the short-term, however, everyone should be tuning to bi-wining Fed Chairman’s April 27th briefing, where every word will be parsed, however un-convoluted his message may be. The markets, whether it be equity, treasury, or currency, are currently placing tremendous faith in the chairman’s continued determination to destroy the dollar in order to bring unparalleled prosperity to the US. While this can make a great trade for reversal if there’s any surprise, it is hard to argue that the Fed worshipers have the upper-hand given the bi-winning Fed’s history.
This article originally appears on benzinga.com