Market Direction

The End of the Dollar Bubble

The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.



From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.

The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.

The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.

As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .

Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.

This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.

The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.

Joseph Trevisani

Market Direction

The rise of the Australian and New Zealand Dollars from their March depths to their current levels has been an Asian success story.

Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.

China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.

The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.

From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.

However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.

Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.

The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.

Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.

The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.

Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.

If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.






Joseph Trevisani

Market Direction

What is the purpose of the foreign exchange market, or any trading market for that matter? It seems like a simple question with a simple answer. The purpose is to facilitate exchange, to permit participants to sell and buy commodities, equities or futures and to trade one currency for another. But that simple definition disguises a world of complexity.

If two parties wish to conduct an exchange, of one currency for another or of an equity or bond for a sum of cash the first question is at what price should the transaction take place? In the consumer world, in a supermarket or department store, the price is predetermined by the seller and is rarely changed. The purchaser measures their need for the item against the price asked and makes the decision to buy or not. There is little discussion and no bargaining over the price. The consumer does not say the price will be lower in a few minutes; I will wait until then to make my purchase. Likewise the seller does not normally remove the item from sale expecting the price to rise in a few days. This basic function of price determination or price discovery is essentially different in a trading market. A market transaction differs from a consumer purchase because both the seller and the buyer continually adjust their price expectations to information flowing out from the market to participants and into the market from outside sources.

Market participants, in theory, incorporate all available information into the prices at which they buy and sell. This is called the perfect information assumption of efficient markets theory. Each participant in the market acts as an independent decision maker. Each decision influences the overall market and price level. The market or to be more precise, the price level of a market traded item, is, at any time, the amalgamation of all the price decisions made by all market participants.

On this one topic-- what should the market price be-- the market reflects the decisions of its participants. In foreign exchange markets the decision makers are the traders, all of them, from the smallest retail trader to the largest hedge fund. But how do 1,000 or 10,000 individual decisions, made in ignorance of each other become a market price? How do we know that the price of this mass decision accurately reflects the wishes of 10,000 people?

If three market participants want to buy a commodity at a certain price level and 50 want to sell, the market price for that commodity will fall. But what actually happens? The three bids in the market will be filled but that leaves 47 sellers. If no other bids enter the market the sellers will begin to react to the lack of bids by adjusting their offering prices down, displaying lower and lower prices until buyers enter bids and a trade is made at the new lower level. The sellers and the buyers incorporated the information flowing out of the market, the temporary lack of bids, into their price expectations producing a new price.

A commentator would perhaps say ‘the market fell today ‘. But a market is not an entity. It is only a method for coordinating the decisions of its participants. What occurred is that each participant in the market reacted to the information coming to them from within the market and their combined reaction is the movement in price. It appears to an observer that the ‘market’ traded lower because the thousands of individual decisions that comprise the movement are not given separate life. Only the mass decision, ‘the price’, is represented.
This sense of the decision making power of markets and the ‘market’ as almost a living entity is reflected in the terms we use to describe the price action. We often say’ ‘the market reacted badly to the news’ or ‘the market took profit today’. We personify the market and its behavior. Of course we all know that there is no “market” somewhere below the pavement on Wall Street making the decisions for the stock exchange. But the common use of this ‘market’ shorthand tends to obscure what is the most important psychological point in understanding market behavior. Namely, that the ‘market’ is a picture of the thoughts of its participants, the market is a snapshot; it is a mass mind.

We can remove some of the sense of mystery from the term, “the market” when we remember just who or what ‘the market’ is? The answer is plain enough, to paraphrase the comic strip character Pogo, “we have met the market and he is us’. The logic, analysis and fear that motivate market behavior have their source within the mind and psychology of market participants, that is, within each of its traders.

When analyzing market behavior it is instructive to keep this very simple fact in mind. The market is a mass mind focused on one topic, price. It represents the momentary culmination all of the external and internal inputs that bear on the price of the traded commodity as ranked by the traders in that market. But even if the method by which the market arrives at a decision is obscure, its ingredients are not—they exist in the analysis, outlook aspirations and psychology of each individual trader.

Since the market is a reflection of the minds of its participants and a traders job is to make profits it follows that a trader’s primary task it to match his decision to that of the mass, to anticipate and mimic the decision of the market. There should be no mystery in ‘the market’ even when it thrashes our positions, for the chances are that the operating logic was known to most of traders. Known and rejected by the losing minority of traders but embraced by the majority.

When our trades lose money, whatever the logic of the position, we can be sure we were not alone. But we can equally be sure that we were in the minority. Had we been in the majority the market would have performed as we had anticipated. The market decision process is that simple. It is a matter of putting our assumptions in line with the majority as often as we can. The most effective tool to achieve that is our own empirically tested market psychology. We are the market, if only we can let the mass mind of the market and not our individuality rule our decisions.

The market does not reward iconoclasts.





Joseph Trevisani