The Daily Trading Report

We have been amused by the comments of treasury secretary Geithner earlier this week in Saudi Arabia regarding the USD.

“A strong dollar is in the interest of the United States. Of course, I deeply believe that,” Geithner said. “Our commitment … to the world and of course, the American people, is to make sure we’ll put in place the policies that can sustain confidence in this economy and this financial system.”

As long time students of political history we believe that political speeches/commentary is nothing more than propaganda. So we don’t take them too seriously. However, what we do take seriously is the underlying reasons for such “banter”. The mere fact that Geithner (and others) have had to resort to these “road show” tactics to support the USD says something in itself. It suggests that there are significant bearish forces at play which are known to the US treasury and not well understood by the general public. At a more micro level experience tells us that when management of a company consistently engage in practices to “talk up” the stock price of a company, more often than not, it ultimately results in disastrous consequences with a significant fall in the company’s stock price, sometimes even bankruptcy. Granted, a company is not exactly a country. However, the same principles apply. When it is all said and done a company is merely just one very big company. Actually many companies are bigger than most countries so perhaps lessons learnt from studying the behaviour of companies are equally applicable to countries. In any case we believe that a currency is to a country what a stock price is to a company. If the USD was genuinely strong, or at least its prospects were, then it is very unlikely that we would see a push by the US treasury/government to “up sell” the USD.

Let us listen to what the market is saying in light of Geithner’s comments? The USD Index has fallen since Geithner’s comments on the 14^th of July. To us this is a bad omen. If Geithner’s “deep beliefs” and talking up efforts are not holding up the USD what will? Global capital flows continue to suggest that the USD Index is about to break to a new multi-week low. Just look at the behaviour of currencies like the Real, Rand, Aussie, and Kiwi to name a few:

The charts above suggest that the next big move is likely to be to the upside.

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We have been watching with interest the behaviour of both the USD Index and the US 30 year treasury over the last two months given the weakness of equity and commodity markets. We have been saying for some time that the lack of “bullish” conviction in the USD Index has been a rather telling factor that the “risk aversion trade” would not get far and that the weakness in equity and commodity markets would be shallow. Note what we said on July 10^th at thedailytradingreport.com. It now appears that the USD is about to challenge the 78.50 level which is its last line of support before last year’s low at 72. We believe that the USD Index will fall below 78.50 over the coming days and then before year end it will have at least traded below the 72 level.

In support of a falling USD is the failure of the US 30 year to break-out of the down trend that began at the start of the year. From a longer term perspective a breach of the 115 level on the US 30 year opens it up to the 105 level which is a significant movement from current levels. We are reasonably confident that the US 30 year will trade at 105 before year end.

In support of lower US treasuries (and by implication a lower USD Index) is the continued outperformance of non US 10 year govt debt (BWX and PREMX). This suggests that “pure” USD assets are rapidly falling out of favour with international investors (and probably many US investors). If US 10 treasuries are underperforming emerging market 10 years sovereign debt this situation is rather serious

So we continue to position ourselves for a weaker USD and weaker US treasuries. Of course we are not expecting them to go down in a straight-line fashion. It is going to be a bumpy ride but we have time on our side.

We have a number of trades on which reflect our bearish USD and UST stance which we discuss with subscribers.

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The weakness in the Dow Industrial is not being echoed by the USD Index……or if it is then it is a very faint echo! This is rather different behaviour than that which occurred over the last 12 months where every time there was weakness in the Dow it was preceded with rather substantial strength in the USD Index.

So what do we trust…….the break down in the head and shoulders formation in the Dow or the lame performance of the USD Index? We believe that currency markets are far more powerful than equity markets so we are sticking to the evidence put forward by the currency market. We also believe that the front runner to currency markets is world bond markets.

The bond market’s action suggests the USD is about to break down again. The charts below are the relative performance graphs of ETFs that track developed market debt ex US (BWX) and emerging market debt (PCY) relative the US 10 year treasury. In both cases the up trends over the last 4-6 months are strong with little to suggest that the up trends are about to come to an end anytime soon. With the breakdown in the Dow we would have expected that these relative graphs to also have broken down by now ……but they haven’t. We don’t know what the future holds but we do know that underlying macro investment themes move in observable trends. In essence we track and trade these trends. Right now the trends below are up……..which paints a rather bearish picture for the USD Index

We would be using any strength in the USD Index to increase short positions……we are sure that by year end the USD Index will be trading at a multi-year low. We believe that there are more effective ways to get short exposure to the USD than simply buying the ETF UDN or shorting USD Index futures.

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So it appears that emerging market bonds are the place to be closely followed by high yield and investment grade corporate bonds, then developed market debt (ex US). The last place to be is in US Treasuries particularly long dated US Treasuries. The action of the world bond markets suggests that we are likely to see a dramatic improvement in world growth and an increase in inflation that will surprise most. From an inter-market perspective this has bullish implications for Equities and Commodities.

There are a number of ways in which to express our thoughts regarding bond markets which subscribers are able to observe.

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Emerging Market Bonds…….you don’t buy “risky” emerging market bonds unless you are genuinely bullish. We believe that the strength of emerging market currencies is being supported by the strength of emerging market bonds. The performance of emerging markets (both equities and bonds) are a reasonably reliable indicator for the performance of commodities. This is due to the sensitivity of emerging markets to world growth. Most emerging markets are heavily involved in the extraction of resources (agriculture, mining, and energy).

The charts below relate to two of the larger emerging market funds available to investors……..both look bullish to us

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