This week marks a possible turning point in the current financial crisis. It seems all of a sudden the world has awakened to <\/p>\n
the risk associated with the rescue efforts of the Federal governments, primarily the oversupply of dollars. <\/p>\n
The trigger for this sentiment change was S&P’s decision on Thursday to lower Britain\u2019s outlook from stable to negative. <\/p>\n
This resulted in a major sell-off across all asset classes. <\/p>\n
Yields on 30 Year treasuries jumped up by 31 bps, the US Dollar lost almost 3.5% against the Euro, and equities gave up most the week\u2019s early gains.<\/p>\n
U-Turn in Risk Appetite<\/strong><\/p>\n Since the fall of Lehman Brothers, the US was seen as the safe haven with treasuries being bid to astronomical levels, and the dollar strengthening. As news of stabilization of economies across the world trickles in, investors are now looking beyond the safe haven and focusing on the end-result of the government policies.<\/p>\n Th anks to the numerous b <\/p>\n ailouts, and the extensive spending plans of the Obama administration, the US Treasury will have to issue a lot of debt to finance Government spending. <\/p>\n Coupled with the Fed efforts to flood the system with liquidity, there is a fear of inflation and the subsequent loss of the Dollar\u2019s purchasing power. As a result, US based assets, which were the safe-haven of choice a few months ago, are being dumped like hot potatoes.<\/p>\n Some of the movement is purely due to trading momentum. <\/p>\n As equities have become range-bound, and no longer trending, traders are looking for new trends. US treasuries and foreign exchange markets are seen by many as the next trending market, and with each move up, more trend-followers are jumping into the fray. <\/p>\n <\/p>\n Selling Overdone?<\/strong> This fact is being acknowledged by world leaders. Eurogroup Chairman, Jean-Claude Juncker<\/a> came out with a statement that the rise in the Euro is not line with fundamentals, and economic recovery in Europe is still some way off.<\/p>\n The White House also reaffirmed that it sees no risk to the US\u2019 AAA rating. One argument in favor of the White House\u2019s statement is that Americans are taxed at a lower rate than Europeans, and the US Government (unfortunately) has the ability to service the rising level of debts, by raising taxes. <\/p>\n <\/p>\n A part of the selling the bond market was driven by bond dealers taking up short positions, before they bid on the large amount of Treasury bonds which will be issued next week.<\/p>\n Euro-Zone: In a Much Worse Shape<\/strong><\/p>\n As I have written in earlier articles, the Euro-zone is facing a financial crisis similar to the US, but with much more limited set of tools to work with. This article in Washington Times<\/a> goes into details of the problems, including the specter of a complete collapse of major banks whose liabilities are often greater than their government\u2019 s ability to bail them out. <\/p>\n <\/p>\n I had an interesting exchange with well known commentator Ashraf Laidi on the forum on his web-site, ashraflaidi.com<\/a>. Ashraf wrote:<\/p>\n \u201c\u2026 making a claim such as the “US is the best of the worst” opens up a whole new discussion that tend to reach socioeconomic boundaries that are beyond the scope of Forex market supply and demand. The hard currency discipline of the ECB may have some macroeconomic hardships but not on its currency, while the Fed is now suffering the worst of corroding home values, contracting credit, soaring unemployment each underlined by severe consumer deleveraging. a country that depended on credit for so much longer than E(e)urope is now having that “drug” taken away from it. And the consumer h as now left <\/p>\n a void in aggregate demand. And that\u2019s not good for the consumer\/debt-dependent US dollar\u201d<\/p><\/blockquote>\n My take-away is that right now, there is a flight out of US Dollars in the Forex markets, which tend to trend and in the short term the flight will continue. <\/p>\n The ECB is constrained by its ability to act in an aggressive manner due to conflicting stake-holder interests, a limited charter and also a fear of doing too much. <\/p>\n A smaller central bank role may allow market forces to work their way through; however it also increases the risk of a much worse crisis.<\/p>\n The ECB\u2019s hard currency discipline may come back to haunt it if it is forced to act in a much more aggressive manner further down the road. So far the ECB has been behind the curve in reacting to the crisis, erring on the side of less intervention. However, they have been forced to follow the US Fed\u2019s lead after some time. <\/p>\n If the same trend continues, the very factors which are pressuring the US Dollar right now may also come to bear on the Euro-Zone. This does not bode well for the intermediate term outlook for the EUR-USD, once the current anti-dollar surge in the market subsides.<\/p>\n My Portfolio<\/strong> My IYR puts are doing fine. I also opened a small bearish put spread position in the TBT. <\/p>\n I expect some pull-back in long bond yields next week and a spread is a low-risk method of taking that view.<\/p>\n Trading Macro Events: A Lesson
\nMy personal view is that the reaction of the market is overdone. This is especially true when it comes to the EUR-USD exchange rate. <\/p>\n
\nI continue to day-trade without establishing any significant position. Today I primarily traded the EUR-USD futures (6E), along with some equity futures. <\/p>\n
\nI had also opened a short Euro position yesterday, based on some topping patterns I had observed. What I had not accounted for is that much of the Asian markets were closed when the ratings news about Britain came out. As a result, after pausing around the close of the US markets, the Euro continued to rise once the Asian markets came on-line, and caught up with the selling. <\/p>\n