Free Post: Davidson on the US Dollar Carry Trade

This is a follow up to a previous post:

I think the Fed has begun to pull the trigger and some of the US$ carry trade is reversing is how I would interpret yesterday’s sell off and today’s lower pace. The US$ did get over 148 Euro/US$ ratio premarket and now has slumped slightly. The entire market has seen some support by this in my view Treasuries especially.

The question is where we go from here. I think Wesbury (Brian) has it right and that the ISM PMI will surprise on the upside. But, will psychology lean towards a positive 12mos or will Malpass’ and other forecasts for a 4Q dip evolve?

I would guess that the ship which has turned will continue its direction and that Wesbury has it right barring an unexpected negative event. Unpredictable concerns include the NY terror team which looks to be larger than first thought and we could have other members moving ahead of which we are not aware. There is also a potential and very likely Israeli attack on Iranian nuclear facilities before year end. Both of these events would strengthen the US$ and cause markets to pull back. Without this type of event, the market will continue to rise in my opinion.

When markets esp commodities continue to rise with a falling US$ AND falling US Rates, I think carry trade. I don’t see inflation in the Dallas Fed numbers (Trimmed mean PCE). I see inflation as coming from lack of economic slack and too much money. Either can be the controlling factor depending on economic weakness. The excess capacity coupled with low demand(low monetary velocity) means that money is collecting in commodities and driving up price. If the stuff is not being bought, then a general inflation cannot occur till consumers begin to spend money on goods.

We have to watch for signals where ever they may arise very, very carefully because velocity is the key. If the Fed acts correctly, then velocity will return as the Fed withdraws excess funding. This will be walking a tightrope. The street has already bet on recovery(w/which I agree) and inflation(which has yet to be seen). Gold is not reliable nor are any other commodities whose prices are part momentum trades with not much relation to anything but trader expectation at the moment.

I see us at the top of a seesaw that is wavering but more or less in balance. Which way it is going remains to be seen. Bernanke has fired a shot across the bow of the carry trade because a severe correction or reversal will not be good for the world economy. We need an appropriate SLOW and TIMELY adjustment.