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Brad
Setser’s Follow the Money reports that the dollar index has started to break down.
(emphasis mine) [my
comment]
Nothing
brings out buyers like higher prices, and other short stories
Posted on Wednesday, July 15th, 2009
By
Mark Dow
DXY, a dollar index, looks like it has started to break down. At my firm,
Pharo, we have been whispering on the trading desk over the last two days
that this was looking increasingly likely. The implications are positive for risky
assets [The DOLLARS are the “risky asset”]. Markets play a
lot of tricks on investors, and you can’t be too certain of anything in
times as unprecedented as these, but, to us, it looks like the short dollar
trade is “on”.
 
Is there a fundamental reason for this? [Hell yes. I can name seven or
more.] Not clear. However, I am pretty confident that if the dollar continues
to sell off the way it has started to overnight and this morning, and Treasuries
continue to weaken the way they have started to, the stories of debasing the
currency and Chinese diversification and the like will bob right back up to
the surface. So, there will at least be a fundamental ‘story’
behind it.
Dollar Index
breaks below 79
Treasury yields are heading up again.
The Fed’s balance sheet expanded $80 billion
The Fed’s balance sheet expanded $80 billion last week (to $2,112
billion from $2,032 billion). The expansion was caused mainly by the purchase
of:
A) 10.5 billion Treasury Notes (mainly 1 to 5 year maturity) (nearly
worthless)
B) 3.9 billion agency debt (IOUs from Freddie and Fannie) (worthless)
C) 64 billion mortgage (+10 year maturity) (toxic)
Total = 78.4 billion
China fails to sell bonds
The Wall Street Journal reports that China again fails to sell all bills in an
auction.
JULY 20,
2009
China Again Fails to Sell All Bills in an Auction
SHANGHAI -- China's Finance Ministry failed to attract enough bids to
complete a bill auction Friday for the third time in two weeks, due to
inflation expectations and tightness in liquidity caused by a large initial
public offering, traders said.
The unsuccessful bill auction comes as China's money supply and bank
lending are expanding rapidly and follows the central bank's sale of
three-month bills Thursday that carried a higher yield than a week earlier
for a third week in a row.
The ministry sold 18.51 billion yuan ($2.71 billion) of six-month bills on
Friday at 1.6011%, less than the planned issuance of 20 billion yuan, traders
said. The rate was higher than market expectations of between 1.4% and 1.5%,
they said.
The ministry also failed to sell all of the bills offered in two auctions
in the prior week.
The People's Bank of China said recently that yuan loans outstanding at the
end of June were up 34 from a year earlier at 1.53 trillion yuan, picking up
from end-May's 31% rise.
Traders said Sichuan Expressway Co.'s IPO this past week locked up 684.6
billion yuan in subscription funds, hurting demand for the bill sale. They
added that IPO-related liquidity pressure won't ease in the near term as China
State Construction Engineering Corp.'s offering, set to be the world's
largest IPO so far this year, will open to subscriptions on Tuesday and
Wednesday.
[On
one hand, China is printing trillions of yuan to fund stimulus spending and
prop up the dollar, and, on the other hand, China is selling debt to mob up
all this printed currency. Now, three auctions have failed, signaling that
China is beginning to lose control over money supply. To solve these auction
failures. China has three choices:
A) Pull back on spending. This is the least unlikely option.
B) Raise interest rates to attract investors to bond sales.
C) Print less money to prop up the dollar. Any strengthening of the yuan will
increase Chinese demand for commodities, driving up prices for the rest of
world.
China is likely to both raise interest rates and strengthen the yuan, but not
enough to significantly slow the growth of its money supply growth. Over the
next three month, China’s inflation problem is going to get much
bigger, causing more bond auctions to fail. At some point, China will stop
raising interest rates and rely entirely on currency appreciation to get its
inflation and money supply under control. This will not be good for the
dollar.
]
My reaction: The
outlook for the dollar continues to worsen.
1) DXY, a dollar index, has started to break down, falling below 79.
2) It looks like the short dollar trade is "on".
3) Treasuries continue to weaken, with yields heading up again.
4) The Fed's balance sheet expanded $80 billion due to the purchase of 78.4
billion toxic securities.
5) China failed to attract enough bids to complete a bill auction Friday for
the third time in two weeks.
6) China's money supply and bank lending are expanding rapidly
7) China's three-month bills carried a higher yield than a week earlier for a
third week in a row.
Conclusion: China’s failing auctions are especially worrisome
because they increase pressure to appreciate the yuan (and depreciate the
dollar).
Eric
de Carbonnel
Market Skeptics
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