It is essential for investors and speculators to understand the linkages between the US dollar and global equities market as part of their financial risk assessment. Uncle Sam’s greenback is a much sought after currency during financial crisis and uncertain times. The simple reason is the US is the only superpower left in this world. Superpower in terms of political, military, cultural and of course economic might. No doubt, US faced twin deficits, namely budget and trade deficit. But the underlying strength of US lies in its value of Gross Domestic Product worth trillions of dollars, innovation, creativity and political stability. China might hold $1 trillion of US dollar as its reserves, but it still lacks the factors mentioned above. So Uncle Sam is not bankrupt or about to go bust. The irony is the greenback has been appreciating since October 2008. Compare that with July 2008. What a stark difference. During that time, US government has been printing US dollar bills at a feverish pace and yet its value appreciates. It didn’t go the way of the banana currency.
As global equities market collapse in panic (especially in 8 days of madness in the first 2 weeks in October), investors, speculators, fund managers and sovereign governments shifted funds toward US Treasury securities. Demand for US IOU bills push up its prices to record high while the yield reaches near zero. That means, thanks to the financial crisis, Uncle Sam is borrowing your money for free! The collapse of global equities market led to the price bubble of US Treasury securities. That explains why US dollar gains strength rapidly. Recently, the US Fed cut interest rate to 0.75% and this has contributed to the weakness of the US dollar. But that is due to interest rate factor rather than the lowering of risk aversion among investors. When investors are risk averse, funds will be parked in safe heavens like the US Treasury. Hence, one should expect the fall of the dollar again after calmness has returned to the global equities market. Investors would be more willing to take more risk by selling the dollar and switching into high yield currency asset. At this moment, I think investors are still risk averse. Another indicator one should look is the weakening of the yen. Due to low cost of borrowing, the yen remains a favorite carry trade strategy. In this strategy, speculators and investors will borrow in yen and convert into high yield currency asset.
At this moment there is a serious misalignment of prices in the financial and commodities market. The weakness of the US dollar is one of the chief factor of the stratospheric oil price last July ($147/barrel). Today, it is priced slightly above the $45/barrel. While the price has dropped 70%, has the US dollar appreciated by 70% against the basked major world currencies? As such, this misalignment cannot carry on for long. It is either the oil price will have to rise again or the US dollar will have to appreciate further. The facts are OPEC has cut production and new oil fields exploration has stopped due to low oil price. Once the economy stabilizes, the full impact of the fiscal measures by the Chinese government will be seen. With the severe shortage of oil supplies, prices will roll up again. Palm oil will follow suit. Its current price of $1700 is simply not sustainable. La Nina is expected in May which brings in heavy rainfall. We are already seeing the impact of global warming. Low harvest against high future demand will push prices up again. Thus, the morale of the story is in this complex and interrelated financial markets, one cannot function independently on its own. Now, you understand why La Nina can affect the prices of your butter and margarine.
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