This note was originally published April 18, 2011 at 14:07 in Macro
Position: We shorted the USD today via the etf UUP.
Call us lucky or good, but we’ve had a pretty good run trading the U.S. dollar in the Virtual Portfolio. Prior to our initiation of another short position in the UUP earlier today (the etf for the U.S. dollar index), we were 19 for 19 in trading the dollar. In our Q2 theme presentation this past Friday, we outlined the negative case for the dollar over the coming months. Today, we got our price.
The first, and likely most important factor when contemplating the dollar, is simply the calendar. Over the course of the next two months, we have a series of catalysts that are all set up to be negative for the U.S. dollar. These are as follows:
- May 16th – Treasury Secretary Geithner gave this as the date that the debt ceiling needs to be extended by to keep the government operating;
- June – In his deficit speech last week, President Obama outlined this as the time frame in which he wants to have the deficit debate finalized; and
- July 1st – Not only is this Canada Day, but it is also the end of Quantitative Easing II.
Notwithstanding the 1% intraday increase in the UUP, which really does nothing more than give us a price from which to reenter on the short side, the calendar events above provide ample opportunity for the global investment community to vote negatively against U.S. fiscal and monetary policy.
Longer term, we have grave concern over the federal government to reach any workable solution on the deficit. The inability to reach a real solution means that we are likely faced with more stop gap solutions ahead of the election next fall. The reality of these stop gap bills, versus real structural reform, is that they are typically more fiction than fact. As the Washington Post reported late last week, based on analysis from Congressional Budget Office (CBO):
“A federal budget compromise that was hailed as historic for proposing to cut about $38 billion would reduce federal spending by only $352 million this fiscal year, less than 1 percent of the bill’s advertised amount, according to the Congressional Budget Office.”
Given the wide divergence between President Obama’s budget and the one proposed by Congressman Ryan, it is increasingly unlikely that a real solution is reached before the 2012 elections. Ratings agency Standard & Poor’s, in an attempt to overcome their status as a lagging indicator, downgraded the outlook for U.S. debt earlier today primarily based on this likely political impasse. If no compromise on a deficit reduction bill is reached, the outlook is exceedingly ugly for the U.S. deficit. According to CBO estimates, which are rosy in terms of certain economic assumptions, the United States is on course for more than $8 trillion in deficit spending over the next decade. This is not positive for the U.S. dollar.
The other key factor for the U.S. dollar is interest rates, and interest rate expectations. Globally, interest rates are going up, while domestically it is becoming increasingly likely that the Federal Reserve will not hike rates until the end of the calendar year, if not later into 2012. The ECB hiked its benchmark rate by 0.25% on April 7th and has signaled its intention to hike further. Conversely, while the U.S. Federal Reserve may not extend its policy of Quantitative Easing come July 1st, it does seem unlikely that the Federal Reserve will raise rates. The implication of this is that the New Carry Trade of borrowing lower yielding U.S. dollars and buying higher yielding Euros is set to continue.
Our levels on the U.S. dollar are attached below.
Daryl G. Jones