Friday – The Fed Finally Supports the Dollar

The dollar rose against the Yen for the first time in 5 days and the most in 2 months this morning.

Bernanke finally came out of his stupor and said the Fed is ready to tighten monetary policy once the economy improves.  Once the economy improves?   Hasn't Ben been telling us how great everything is for the past 3 months???  The Dollar Index, which tracks the currency against six U.S. trading partners, recovered from a 14-month low after Bernanke signaled interest rates may rise when the economy “has improved sufficiently.” The yen dropped against all but three of the 16 most-traded currencies after Japan’s machinery orders gained less than forecast. 

“People took the comments as an opportunity to take some money off the table before the weekend,” said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. “They came at an opportune time and allowed some people to get some profit out from bets against the dollar.”  

White House economic adviser Lawrence Summers repeated the administration’s commitment to a strong dollar, citing recent comments by U.S. Treasury Secretary Timothy Geithner.  “He made it very clear that our commitment is to a strong dollar based on strong fundamentals,” Summers said at a Bloomberg forum in New York.  

We've been talking dollars all week at PSW because it has been my opinion that there has been nothing supporting this rally, especially on the commodity side, other than dollar weakness and fears of further dollar weakness.  It's been a case of so far, so wrong though as our short plays have gotten hammered this week and I was thinking of opening this morning's post by saying:  "Hi, my name is Phil and I'm a shortaholic" because, try as I might, I have been unable to stop taking short positions all week.  Even yesterday, as we tested (but did not break) our upside target levels, I found myself putting up 8 bearish trade ideas for Members (DIA puts, FSLR puts, GLD puts, USO puts, EDZ calls, TBT calls, TZA calls, SRS calls) and just one bullish play, which was a DIA vertical spread to cover, just in case we got burned by today's open.

Fortunately, it doesn't look like I'll have to do a mea culpa this morning as FINALLY the dollar is finding some support at pretty much the exact same place we found support on 9/23, which was the beginning of our last 5% downtrend in the market.  We're not going to get too excited though and we'll try to balance out a bit into the weekend but at least a small bit of sanity is creeping back into the markets as people begin to realize that they can't count on the dollar to support $1,050 gold or $70 oil.  Now traders will have to scramble for fundamental arguments to support paying 50% over last October's price for gold and 100% over last October's price for oil in an economy that has not really gotten any stronger at all since that time. 

Not getting much coverage in the US media is the move I predicted earlier this week – the Asian Central Banks are intervening in the currency markets to stem the appreciation of their currencies against the dollar.  The central banks identified by traders as substantial buyers of US dollars included Thailand, Malaysia and Taiwan. Hong Kong and Singapore, which both have managed currency regimes, were also buyers.  Traders said that the central bank interventions appeared to be aimed at controlling the pace at which the US dollar declines rather than solely to stop Asian currencies appreciating.  Simon Derrick, at Bank of New York Mellon in London, said: “Other Asian central banks outside China are naturally looking to aggressively defend their competitive edge against undesirable currency strength as the dollar weakens.”

The Nikkei was certainly pleased with this action and that index rose 1.9% this morning, back just over 10,000 (10,200 is recovery) despite a poor showing from August machine orders as exporters were greatly relieved to see the dollar back over 89 Yen.  Shanghai came back from their week off and popped right up to the 5% rule but that was to be expected after a week off.  The Hang Seng was not playing catch-up and flatlined while the BSE lost 1.2% and is now down 3.2% for the month.  The Baltic Dry Index is kicking back up strongly off the bottom but our Trade figures were not all that encouraging but are rebounding somewhat and our own Trade Deficit was $30.7Bn as our exports increased 0.2% and imports decreased 0.6% – yet another indicator of lack of US demand. 

Despite the lack of actual demand in the inventory reports, the retail sales number or the import data, the IEA raised their forecast for oil by 200Kbd to 84.6Mbd, less than 7Mbd under global production capacity.  Interestingly, despite this "good news" for the oil industry, British fund manager Neil Woodford sold his stakes in BP (BP) and Shell (RDS.A); the positions totaled 8% of his $28.8Bn funds. It's "getting increasingly expensive to find new oil and gas reserves, and when you look at the cash-flow dynamics, you see that at the sort of oil prices we are now seeing, both Shell and BP fail to generate enough cash to cover both their capital expenditure and their dividends," he said.  I'm going to go with the guy managing $28Bn and stay short on OIH and the majors…

Europe is down slightly just ahead of our open, recovering from a half-point dip in early trading.  "After recovering strongly, markets might appear to be losing some of their momentum. Nevertheless, we expect equity markets to remain in a generally positive mood," said an equity note from Erste Group.  Among the European blue-chips, Telefonica was the biggest gainer, up 2.2% after the company raised its dividend for next year.

We're bearish but well-hedged but ready to get more bearish if we get a proper breakdown.   As always in this crazy market, we take our bear-side profits quickly off the table because they sure don't seem to last long.  Our upside breakout levels remain Dow 9,829, S&P 1,071, Nas 2,146,  NYSE 7,047 and RUT 620 and we tested but did not break them yesterday – which is why we ended up with so many bearish bets.  Our aim is to go neutral into the weekend, we're not expecting a cliff dive and Monday is a holiday and should have slow trading, which usually means an up day. 

Have a great weekend,

– Phil