Dead Cat Bounce
What's going on with the greenback?
from undisclosed source

The dollar had been weak for weeks. Actually it had been drifting lower for many months. The U.S. posture, official posture that is, was for a "strong dollar". But many officials could barely suppress a grin with each downtick in the greenback. Soon even the media was talking about the dollar trading one for one with the yen. Other articles suggested the sinking dollar would not cause any problems in Euroland until maybe 135/140. The result of all this official winking and media punditry was to get everybody and his sibling to short the dollar. The dollar shorting, added to the mountain of trade deficit dollars sent foreign central banks, particularly Japan, scrambling. Trying to hold back the tide, or in this case, the tsunami, they intervened on a massive scale. Then, awash in dollars, they rushed to recycle them by buying U.S. Treasuries. By coincidence this allowed them (the central banks) to fund the growing budget deficit in the U.S. Not classic economics by any means, and rather an historic oddity. But, very convenient for both the U.S. Treasury and U.S. Fed. Then about a week or so ago the dollar stopped going down in a straight line. Some folks thought it was a relief rally. The dollar shorts called it a dead cat bounce. Others thought it was a temporary and transient victory for the Bank of Japan. Whatever the reason, what followed was several days of bobbing and weaving as traders looked for chart direction.

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Then two key events popped up. One was the ISM report. As we have previously noted, a key portion was a strong employment section. That led to upping estimates of this Friday's payroll data. This prompted what looked like short covering in the dollar. Those who didn't cover apparently put in protective buy stop orders. At about the same time Japan had a ten-year auction that needed a flea collar. That prompted a thesis that all that intervening and recycling was reflating both the Japanese economy and its currency. Proponents cited the 20% jump in the Chinese money supply from recycling. (The two are not analogous but we'll stick with this point.) The Japanese reflation thesis was another blow to the dollar bears. The dollar starts to rally sharply touching off those buy stops. That causes the dollar to rally more sharply further panicking the dollar shorts. Now the bond guys start to fret that a stronger dollar needs less intervention. Less intervention means less recycling. Less recycling means fewer foreign buyers for the rapidly growing deficit. That could put upward pressure on rates as government bonds crowd out other borrowers. The Fed could take the place of the foreign central banks but that explode the money supply and with it inflation. Stock guys watched the dollar and bonds. They caught their drift and put the wallet back on the hip. The result... ..a downward reversal. Greenspan's speech provided no solace since his topic just happened to be the very topic we just discussed.

posted by prof_booty | 03:21 PM