Best of the Week
Most Popular
1.U.S. Housing Bull Market Over? House Prices Trend Forecast Current State - Nadeem_Walayat
2.The Coming U.S. Economic Collapse Will Trigger a Revolution - Harry_Dent
3. Stock Market Crash a Historical Pattern? - Wim_Grommen
4.Global Panic - U.S. Federal Government Stockpiling Ammo – Here’s What We’re Going to Do - Shah Gilani
5.AI, Robotics, and the Future of Jobs - Aaron Smith
6.This is Your Economic Recovery With and Without Drugs - James_Quinn
7.Gold and Silver Price Getting Set To Explode Higher - Austin_Galt
8.The Something for Nothing Society - Lifecycle of Bureaucracy - Ty_Andros
9.Another Interesting Stock Market Juncture - Tony_Caldaro
10.Inflation vs the Deflationary Straw Man - Gary_Tanashian
Last 5 days
The Ultimate Demise Of The Euro Union - 1st Sep 14
Palladium Price Breaks Multi-Year High Over $900 - 1st Sep 14
When Complexity Becomes Chaos - 1st Sep 14
Designer War By Default - 1st Sep 14
Islamic State or Russia? Ten Key Questions Towards Pragmatism - 1st Sep 14
Mixed Emotions for the Gold Market - 1st Sep 14
These Clowns Are Dragging Us Into War with Russia - 1st Sep 14
Marx And The Capitalist Cancer Of Overproduction - 1st Sep 14
Scottish Banks Salivating at the Prospects for an Independent Scotland of 6 Million Debt Slaves - 1st Sep 14
Small Man Europe Is Now In “Effective State Of War” With Russia - 31st Aug 14
The Unintended Blowback Of False Flags - 31st Aug 14
Tesco Supermarket Death Spiral Latest Profits Warning and Dividend Slashed - 31st Aug 14
Dow, Gold and Silver - A Last Stand, A Fake Out And A Surge - 31st Aug 14
If U.S. Consumers are so Confident Why aren't They Spending? - 31st Aug 14
Scotland Independence House Prices Crash, Deflationary Debt Death Spiral - 31st Aug 14
Obama’s “Catastrophic Defeat” in Ukraine - 30th Aug 14
Stock Market Inflection Point Approaching - 30th Aug 14
Gold And Silver - Elite's NWO Losing Traction. Expect More War - 30th Aug 14
Corporations Join Droves of Americans Renouncing US Citizenship - 30th Aug 14
Peter Schiff U.S. Housing Market, House Prices Bubble Warning - 30th Aug 14
Russia, Ukraine War - It’s Time to Play the “Gazprom Card” - 29th Aug 14
The One Tech Stock Investment You Should Never Sell - 29th Aug 14
Bitcoin Price $500 as Current Downside Barrier - 29th Aug 14
Don't Get Ruined by These 10 Popular Stock Market Investment Myths - 29th Aug 14
Low Cost Transcontinental Gold - 29th Aug 14
Gold Bullish Central Banks Should Give Money Directly To The People - Helicopter Janet? - 29th Aug 14
US House Prices Bull Market Over? Trend Forecast Video - 29th Aug 14
The Fed Meeting at Jackson Hole Exposed Yellen’s Greatest Weakness - 29th Aug 14
AAPL Apple Stock About To Get sMACked - 29th Aug 14
A History of Unlimited Money: Learn From It or Repeat Its Mistakes - 29th Aug 14
How You Can Play to Win When Market Makers Are Calling the Shots - 28th Aug 14
EU Gas Supply Is In Real And Imminent Danger - 28th Aug 14
Central Banks at the Root of Evil - 28th Aug 14
European Bond Market: Bubble of all Bubbles! - 28th Aug 14
Employers Aren’t Just Whining: The “Skills Gap” Is Real - 28th Aug 14
The ISIS Menace - Just What We Need, Another War - 27th Aug 14
The Risky Business of Methane-Rich “Fire Ice” - 27th Aug 14
CFR Recommends Policy Shift that is Very Bullish for Gold - 27th Aug 14
Ukraine Standoff Signals Global Power Shift - 27th Aug 14
Stock Market Panic Decline Begins - 27th Aug 14
The Monopoly of the Government Education Cartel - 27th Aug 14
How to Invest in Silver Today for Double-Digit Gains - 27th Aug 14
The Big Solar Energy Breakthrough We've Been Waiting For - 27th Aug 14
U.S. Empire’s Bumpy Ride - 27th Aug 14
Gold Market and the Interest Rate Trap - 27th Aug 14
Stock Market Staring Into the Great Abyss - 27th Aug 14
A Look at the Coming 30-year Inflation Cycle - 27th Aug 14
Forex Trading - Will USD/CHF Rally Above 0.9200? - 27th Aug 14
Europe’s Depressing Economy Dog Days of Summer - 27th Aug 14
How The Coming Silver Price Bubble Will Develop - 26th Aug 14
A Nation of Shopkeepers - Supply-Side (Voodoo) Economics? - 26th Aug 14
Stock Market Bear Tracks Abound In Wall Street - 26th Aug 14
65,000 U.S. Marines Hold up a Mirror to the Economy - 26th Aug 14
Bitcoin Market Provides Clues for Investors - 26th Aug 14
The Key to Trading Success - 26th Aug 14
Will The US Succeed in Breaking Russia to Maintain Dollar Hegemony?... - 26th Aug 14
Even Mainstream Academia Worried about Massive Bubbles in Markets - 26th Aug 14
Iraq and Syria Follow Lebanon's Precedent - 26th Aug 14
Colonization by Bankruptcy: The High-stakes Chess Match for Argentina - 26th Aug 14
Dow Stock Index On The Cusp - 26th Aug 14
Prohibition Laws and Agency Regulations - 26th Aug 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Biggest lie in Stock Market History Revealed

The Rising U.S. Dollar Myth

Currencies / US Dollar May 01, 2013 - 04:38 AM GMT

By: Axel_Merk

Currencies

Year-to-date, the U.S. dollar is up; does that mean we are in a rising dollar environment? Or is it an opportunity to diversify out of the greenback?


Last year, with all the turmoil in the Eurozone, the euro was up 1.79% versus the dollar; that appeared to be the best the U.S. dollar could do in times of turmoil. Of the major currencies only the Japanese yen was down versus the U.S. dollar:

Year-to-date, the dollar index, a trade weighted index comparing the U.S. dollar to a basket of six major currencies, is up 2.95% as of April 29, 2013. What many are not aware is that this index has not really been updated since it was first created in the early 1970s, giving the euro a 57.6% exposure. The dollar’s downward trend has been slowed in recent years in large part by the turmoil in the Eurozone. Additionally, the New Zealand dollar for example, which is not in the index, is up 3.37% year-to-date.

To ascertain what may happen to the dollar, let’s look at the greenback from a couple of different angles:

Myth: U.S. dollar’s safe haven status

In recent years, when there has been talk about a “flight to quality” benefiting the U.S. dollar, we had a couple of observations:

•Flight to quality may be a misnomer: our analysis suggests the dollar tends to be in demand in times of turmoil because of liquidity, not quality considerations;
•Since the onset of the financial crisis, each time the pendulum swings in favor of the U.S. dollar, it may be swinging there less so;
•The balance sheet of the U.S. appears to be deteriorating at a faster pace than the balance sheets of much of the rest of the world;
•Wherever there is a crisis, it is being “patched up”, suggesting that when the pendulum once again favors risky assets, more money might flow towards those assets; and when the pendulum swings once again in favor of the U.S. dollar, it may be less and less of a beneficiary.

In other words, the safe haven status of the U.S. dollar may slowly be eroding.

Myth: a rising rate environment favors the U.S. dollar

Assuming one believes interest rates are to head higher, it may be an expensive proposition to buy the U.S. dollar: as foreigners have historically had a major appetite for U.S. debt, their enthusiasm is historically trimmed back as the bond market turns into a bear market. As a result, early to mid phases of tightening by the Federal Reserve (Fed) have historically often been associated with a weaker dollar. It’s the late phases of a tightening cycle that the dollar historically tends to benefit, as the next bull market is anticipated for bonds. There may be little historic precedent for the environment we are in, but a rising rate environment, in our assessment, does not favor the U.S. dollar.

Myth: the Fed’s exit is near

It was just about a year ago that Fed Chair Ben Bernanke pronounced in a press conference: Let’s be humble. He then clarified that meant that liquidity should not be mopped up too early; that we have to be sure that the recovery is firmly entrenched before one should consider an exit from the highly accommodative monetary policy.

To understand Bernanke, consider that in his own words, he has repeatedly stated that he believes one of the biggest mistakes during the Great Depression was to raise rates too early. As a result, the Fed has promised to keep rates low, purchased longer-term bonds, and engaged in Operation Twist. All of these policies reflect an effort to keep long-term rates low. Yet, a little over a year ago, a series of good economic data points caused the bond market to sell off rather sharply on the long end. In our assessment of Bernanke’s thinking, that was undesirable as the recovery was nascent. Hence, the Fed doubled down by announcing an unemployment rate numerical threshold that would guide rate policy, moving the focus evermore away from inflation and towards employment. Not surprisingly, inflation expectations inched higher. The below chart is one of the many ways one can look at inflation expectations:

Bernanke has emphasized the Fed’s communication strategy and the importance of guiding market expectations. Without getting too technical about the chart, our assessment is that Bernanke is comfortable with inflation expectations at the upper range of this chart and may even consider more aggressive monetary easing when inflation expectations drop, as has occurred in recent weeks. A lowering of inflation expectations may suggest to the Fed that all the monetary action, all the “money printing” hasn’t been enough.

Myth: economic growth will support the U.S. dollar.

Skeptics still point out that it doesn’t really matter whether the “exit” will come tomorrow or down the road: the “exit” is now coming closer and, with it, the market has to start pricing it in. Well, if it does, we might be in for another surprise. In our analysis, the biggest threat to the U.S. dollar may be economic growth. Let all the money that’s been created by the Fed “stick” (economic growth may drive excess bank reserves to work), and it may be rather difficult to mop up the liquidity that’s been made available to the system:

•Technically, the Fed has pretty much ruled out selling the securities it has acquired. That’s because the Fed might have to sell them at a loss.
•The Fed has indicated it may increase the interest it pays on reserves to mop up liquidity when the time comes. Not only may that result in no longer paying over $80 billion in “profits” to the Treasury (the more securities the Fed buys by creating money with the stroke of a keyboard, the more interest it earns, the higher the Fed’s “profits”), but it will lead to tens, if not hundreds, of billions in direct payments to large banks. While there may be an academic justification to make such payments, the political fallout could lead Congress to suspend the Fed’s ability to pay interest on reserves, botching the exit strategy.

Additionally, it’s likely that economic growth would drive interest rates higher across the yield curve. More important than the technical restrictions mentioned above may be the fact that the U.S. government cannot afford a high cost of borrowing to service the national debt. The average cost of servicing U.S. debt has come down from about 6% in 2001 to just over 2%. That cost of borrowing should continue to drift downward for a while as higher coupon Treasuries mature and are refinanced with lower coupon Treasuries. We are not predicting that the average cost of borrowing will zoom back up to 6% in the short-term, but what can come down, can also go back up. Even at 4%, discretionary spending by Congress will be crowded out by interest payments. Importantly, it may matter little what cost of borrowing the government can bear; more relevant may be the perception of the sustainability of U.S. government debt. Spain had very prudent debt management, with an average maturity of about 7 years for its debt outstanding; yet it took very little time for Spain’s government to be on the brink of a bailout.

The U.S. bond market does not currently reflect serious concern about the sustainability of U.S. debt. However, without major entitlement reform, in particular in social security and Medicare, the numbers simply don’t add up. Many have argued that, over time, Congress will come to its senses and indeed engage in reform. We are actually quite optimistic ourselves: however, we believe that the only language politicians listen to is that of the bond market. The Eurozone is proof that policy makers choose between the cost of acting versus the cost of not acting. Whenever possible, politicians kick the can down the road. But unlike the Eurozone the U.S. has a current account deficit. That is, the U.S. dollar may be far more vulnerable to a bond market that’s imposing reform on policy makers than the Euro has ever been.

The reason we put this discussion under the header of economic growth is that it may well be good economic data that help to unravel the perception that U.S. debt is sustainable as yields return to more historic levels.

For a more detailed outlook on currencies, please read the Merk Gold and Currency Outlook. For purposes of this analysis, we want to show that it’s far from clear that the U.S. dollar will benefit in the environment to come. Indeed, the downside risks to the dollar might be as high as ever. Ultimately, there may be no such thing as a safe asset anymore and investors may want to take a diversified approach to something as mundane as cash. Please make sure you sign up for our newsletter to be the first to learn as we discuss global dynamics affecting the dollar. Please also register to join an upcoming Webinar; our next Webinar is on Thursday, May 23, expanding on the discussion herein.

Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds, www.merkfunds.com

Rick Reece is a Financial Analyst at Merk Investments and a member of the portfolio management

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit www.merkfunds.com.

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at www.merkfunds.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

Axel Merk Archive

© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014