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With
the Chinese calling Congress' bluff yesterday and moving the Yuan's peg to
the Dollar, the focus of the investment world will once again be back on the
world's currencies. Ironically, they may disappoint.
There
will certainly be plenty of conjecture about the balance of currencies in
China's new "basket," but since China hasn't released the details
of that basket's make-up (and likely never will), we will all be left to sift
through any clues we can find in time through market action in these
currencies.
Aside
from the initial trading spasm following the announcement, the reaction has
been remarkably quiet, which suggests this is merely the first step in a
long, slow process in which the world's central banks try to manage their way
out of today's fiscal imbalances. If so, then it makes sense to simply take
our cues from continued market action, so a look at recent currency action
will likely be our best guide as to what comes next.
First,
the U.S. Dollar:
www.stockcharts.com
It can
be seen in the chart above that the Dollar recently reached not only an overbought
state, but an area of measurable chart resistance in the 90-area on the USD
Index. In addition, the greenback was also extremely overbought recently
according to point & figure 10-week trading bands (not pictured), a
useful short-term gauge. Because other foreign currencies remain oversold and
the Dollar has not yet become so, a further correction from its recent highs
remains in order.
One
positive for the Dollar: while it has clearly been working off its overbought
state, it hasn't declined measurably from those recent highs, a sign of
strength. Since there isn't a great deal of chart support until down below at
85, a pullback to that level is a possibility, but for now it appears to be a
time, not a price correction for the USD.
Having
been underweight foreign currency exposure since the fourth quarter of last
year (and having first written about it in December of '04), I'm comfortable
in cautiously nibbling on a few select foreign currencies at the moment,
slowly raising non-Dollar exposure for clients back to more
"normal" levels (but by no means overweight). Here, however, is a
picture of a currency that is still to be avoided, in my opinion:
www.stockcharts.com
A
1-year look at the Euro paints nearly the opposite picture one sees in the
Dollar; while the Single Unit has for weeks been trying to work higher from a
very oversold condition, it has gone essentially nowhere during that time.
This is a flashing yellow light of caution, if not an outright red one. The
British Pound has been under such awful pressure lately (partly due to the
terrorist activity we've seen there) and remains much more oversold, so
perhaps a bounce in the Pound could help carry the Euro a bit higher in
sympathy (the increasing possibility of a rate cut in the U.K., by the way,
wouldn't make this idea one to bank on), but on its own the XEU continues to
look very weak.
Further,
the chart shows that each time the Euro's short-term momentum indicators have
rushed from oversold from overbought in 2005, the currency has had a hard
time making any headway on the upside, a poor sign. In this light, the
current attempt at a bounce looks no different.
Those
hoping for a rally in the Euro will learn a lot more on its next pullback; if
it can move back to an oversold condition without making a lower low (which
looks unlikely at the moment, but we'll wait and see), that would be the
first positive divergence the currency has seen in some time and might
finally signal that the Euro was ready to move higher on a sustained basis.
Although
the Fed's raising rates (which, despite what you may hear, is indeed one key
driver of a currency's movement against others - see the chart below for a
simple, long-term picture that while the correlation between interest
rates/currency strength or weakness isn't perfect, there's strong enough
correlation there to be compelling),
 
www.decisionpoint.com
it is
appearing more and more that the next couple of hikes are likely priced into
the Dollar. On the other hand, while downside risk to the Dollar remains
visible, technically, it has proven quite resistant to such pressure of late.
Interestingly,
now that the Chinese have re-valued, we may witness a prolonged period
without much in the way of market-moving currency news. The second half of
2005, therefore, may see little more than a digestion of the first-half move,
a period of technical consolidation that allows us to better determine the
next trend in the world's currency system.
A Word
about the Yuan
Yesterday's
revaluation should set off fireworks from the Dollar perma-bears. While many
of the arguments of these types are correct (that fiat currencies assess a
hidden tax on savers, that they provide the basis for the runaway welfare
state, that we're sadly witnessing a massive wealth transfer from America to
Asia, etc.), you're also likely to hear many forceful prognostications that
this marks the beginning of the end for the US Dollar.
In
fact, yesterday's move wasn't the beginning of anything; it was simply
another move by one of the world's central banks, one certainly acting in its
own interest, but also doing its part to work slowly out of these massive
global economic imbalances faced by all economies. It's a process that is
almost certain to take place at a glacial pace, regardless of financial
accidents along the way (risks for which are indeed present currently). The
Dollar isn't going to collapse tomorrow. The end of American Empire isn't
upon us. The financial world is evolving, in a precarious manner, to be sure,
but slowly.
Here
are a few things to keep in mind about the Yuan revaluation you're unlikely
to hear from many writers on the subject:
1. While
the Yuan revaluation is highly significant and it does highlight that the
world is trying to slowly move away from a system in which one currency is
the global standard, it was also an open admission by the Chinese that their
financial markets are not nearly mature or healthy enough to withstand a
fully floating currency, despite their manufacturing prowess and recent rate
of growth.
2. The
idea of the Yuan as a threat to become the world's reserve currency is
fantasyland anytime in the near future. The country has none of the 4 main
attributes the brilliant folks at Gavekal Research, for example, suggest is
necessary to issue the world's reserve (financial, agricultural, military and
technological dominance), let alone a legal system the rest of the developed
world would put such faith in.
3. It is
China that is now on the hot seat to get its own fiscal house in order;
planning to liberalize its capital account in 2008 as part of its ongoing
reforms, which would open up financial flows into and out of the country, the
Yuan could then be the currency under siege if it hasn't cleaned up its
banking system and equities markets by then.
I'll
have more to write in-depth very soon on the outlook for global currencies,
but in the meantime, keep your wits about you and remember that despite the
fact we live in truly historic economic times, the financial world continues
to evolve slowly in front of us. And in the second half of 2005, there may be
a lot more smoke than fire as far as currency fluctuations go.
Chip
Hanlon
President, Delta Global Advisors, Inc.
19051 Goldenwest,
#106-116 Huntington Beach, CA 92648 Phone: 800-485-1220
Fax: 800-485-1225 www.deltaga.com
A widely-followed
market commentator, Mr. Hanlon served as the C.O.O at Euro Pacific Capital
prior to taking the reigns at Delta Global. He had previously been the
President of Unfunds, Inc. and spent 7 years prior with Sutro & Company
as a Vice President and the company's Los Angeles Director of Syndicate
Offerings.
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