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May 23, 2006
Why Betting Against The Dollar Is Tricky Business
In the craps shoot that is economic forecasting, few games favor the house more than trying to predict exchange rates. Perhaps as a consequence, I was taken by this, from the Wall Street Journal (page A1 in the today's edition):
Stocks in developing countries tumbled yesterday, extending one of their biggest losing streaks in nearly a decade, as growing jitters about the global economic outlook amid rising interest rates prompted investors to abandon riskier markets world-wide...
Driving the sell-off: Expectations that central banks around the world, from the U.S. to Europe and eventually Japan, may be preparing to raise rates more aggressively than previously anticipated. News last week that the U.S. consumer-price index rose faster than expected raised the specter that interest rates will have to climb further to curb inflation. Even the recent retreat in commodity prices has not been enough to blunt inflation fears, and since many developing countries are commodity producers, these declines have weighed on their economic outlooks...
... given the current global economic scenario, "these markets are going to be in for a rough couple of months," said Carlos Asilis, a Miami-based portfolio manager for Vega Plus Capital Partners, which has $2 billion under management.
Here's a reminder of how global economic stress tends to affect the value of the dollar:
Of course, the current circumstances are a long way from the full blown crises in the latter 1990s. And things improved today...
Emerging markets outside Asia began recovering from Monday's selloff, tracking rebounds in commodities and gains in most developed-market equities.
Although Monday's selloff followed two weeks of declines that reduced, if not wiped out, many of the gains so far this year, investors are showing signs of resilience.
"What you've seen over the past week or more has primarily been a case of position reduction as risk appetite has declined," said Stephen Gilmore, a global emerging-markets strategist for Banque AIG, a unit of AIG Financial Products Corp. "It's always very hard to know how long risk reduction will continue. I don't think things [in emerging markets] fundamentally have changed."
... and you might argue that the U.S. is particularly poorly positioned in the current environment. On the other hands, The Skeptical Speculator noted that, at least yesterday, "US stocks were relatively resilient compared to the other stock markets"; in Euroland French business confidence is slipping and German investor sentiment stumbled as Eurozone industrial orders fell; and the Bank of Japan has yet to show any urgency in moving short-term rates away from zero.
All of which may amount to exactly nothing. I, along with many others, fully expect the trend in U.S. current account deficits to reverse -- really, any day now -- and I will be less than shocked to see a depreciation of the dollar along with that adjustment. But to anyone waiting for the greenback slaughter, I have one question: If, heaven forbid, the global economy goes south, who ya gonna call?
ANOTHER UPDATE: Menzie Chinn discusses the impact of dollar depreciation on domestic inflation, at Econbrowser.
YET ANOTHER UPDATE: I finally caught up with Brad Setser's post, making much the same point, but with a lot more numbers to back his case.
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