I trust everyone will enjoy the holiday season. We send our warmest greetings to all and are writing this note partially for that purpose. There is, however, another reason for our writing.
A TREND OF THE LAST YEAR IS OVER. THE U.S. DOLLAR RALLY IS ENDING.
In the last few weeks many currencies have begun to mount rallies versus the dollar. Within last few days, even the chronically weak Japanese Yen, has rallied versus the U.S. dollar.
Why has the dollar rally begun to unravel? It is because interest rate differentials between the dollar and other currencies may be nearing a peak differential. U.S. short-term interest rates have been rising for quite a while and yesterday the Federal Reserve raised them again. This is compared to the interest rates of most other currencies, which have been kept fairly flat. Therefore, the interest rate differential between the U.S. dollar and other foreign currencies continued to grow.
THE CARRY TRADE
An old game in the global bond and currency markets is the carry trade. In the carry trade, the speculator borrows large quantities of money in one currency with a low interest rate and invests that money in a currency with a much higher interest rate.
For example: If you borrowed $1 billion of Japanese Yen and invested that $1 billion in U.S. T-bills a year ago you would have made an interest differential of about 2%. Many speculators piled into carry trades like this, forcing the Yen down and the U.S. dollar up.
Now however, many countries are enjoying more economic growth, which is causing inflation to perk up in their currencies. In reaction, the European Central Bank and others are beginning to raise rates to combat inflation. It is anticipated that the U.S. will raise the Fed Funds Rate a maximum of 2 or 3 more times in the next few months. Most speculators believe that after May at the latest, and possibly in February, the Fed may be through raising rates for some time. This will give other currencies a chance for their interest rates to catch up with U.S. rates, and should attract buyers to their currencies.
The markets are discounting the probability of this occurrence.
WHEN THE MARKETS SEE THE END OF U.S. RATE INCREASES THEY BEGIN TO DISCOUNT A LOWER DOLLAR AND THAT IS WHY THE U.S. DOLLAR RALLY IS ENDING.
We believe that the U.S. dollar will under perform most major currencies for the foreseeable future.
THIS IS GOOD FOR GOLD, WHICH OFTEN ACTS AS A SURROGATE CURRENCY.
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You can also read Monty Guild’s past periodic market and economic commentary articles by going to the Commentary Archive on our web site www.guildinvestment.com.
Monty Guild is Chairman and CEO of Guild Investment Management, Inc., a registered investment advisor. All material presented herein is believed to be reliable. Investment recommendations and opinions expressed in these reports may change without prior notice.