|
Why the Dollar will Hit New Lows
FXCM Enhanced Index Programs |
|
|
|
|
|
|
|
|
With the Dollar Index hovering near all-time lows, some analysts see bargain. However, buying dollars may be as tough as catching a falling knife. None of the factors that have been responsible for the decline of the greenback disappeared. In fact, if anything, the situation has only become worse. |
|
|
|
Here are a few reasons, despite the steep decline, why being a dollar bear may still be a good idea in 2008 |
|
|
|
 US slowdown turns into a severe recession |
|
10mm households foreclosed, US consumer devastated |
|
| Low rates make lead to USD carry trade |
|
Will the Dollar be the new Yen? |
|
| Low dollar leads to less foreign investment |
|
How does the US finance the deficit? |
|
| Gulf states de-peg from the dollar |
|
Dollar losses it reserve status dominance |
|
|
|
|
|
US Slowdown Turns Into a Recession |
|
 10MM households in foreclosure
Massive decline in consumer demand |
|
| When it comes to the US economy, what is the elephant in the room? Clearly, it is housing. Would the Federal Reserve have cut rates by a whopping 125bp in just one month if the housing sector were not in such terrible trouble? |
|
|
|
Dollar Index Through 1998-2008 |
|
 |
|
|
|
|
|
Absolutely not. While the direct impact of housing accounts for only 5% of GDP, analysts estimate that since 2002, housing’s indirect influence on the US economy, via the finance and retail sectors, could be as much as 40%. Little wonder then that the greatest fear facing US policy makers is the possibility of 10 million households facing foreclosure in the next 24 months. The situation appears so dire because of a deadly combination of rapidly declining housing prices in conjunction with a massive wave of resets of Adjustable Rate Mortgages. As poorly capitalized home owners are faced with the prospect of markedly higher monthly mortgage payments while the equity in their houses deteriorates, many find themselves “upside down” and owning more of their loans than their homes are worth. In such circumstances, some home owners have chosen to simply mail the keys to the house to their bank and default on the loan—a move derisively termed as “jingle mail.” |
|
|
|
If the beleaguered mortgage payers decide to default en masse, the repercussions for the US economy would be disastrous; the result of which is the possibility of many key players in the financial sector being forced into bankruptcy. FDIC insurance notwithstanding, the ripple effects could endanger assets of fiscally healthy consumers as well, and the concomitant contraction in demand would bring economic activity to a halt. With consumption making up more than 70% of the US economy, a sudden and sharp decline in net worth would push the US economy from slowdown into a full blow recession, necessitating further rate cuts from the Fed. |
|
|
|
The US Dollar Becomes the New Japanese Yen |
|
|
|
Dollar interest rates decline to 1% or less
Europe, Australia, New Zealand, and the UK maintain or increase their interest rates
Dollar comes under constant pressure from carry trade flows |
|
|
|
Anyone that is familiar with the forex markets knows about the "carry trade"—the method by which traders buy high-yielding currencies, like the New Zealand dollar, and fund the trade in currencies with low interest rates, like the Japanese yen, in order to reap the greatest profits. While investing in carry trades is never a sure bet, (they are prone to sharp reversals during periods of turmoil in financial markets leading to potential losses), the prospect of raking in additional profits via accumulated interest always keeps risk-seekers coming back for more. |
|
|
|
Since September of 2007, the Federal Reserve's aggressive rate cuts have dragged the overnight lending rate to a two-and-a-half year low of 3.00 percent, pushing the US dollar down towards the low-yielding ranks with the Swiss franc and Japanese yen. When—not if— the Fed enacts additional rate cuts, traders that used to be drawn to the Japanese yen as a funding currency for carry trades may now turn to the US dollar, especially as other central banks, such as the European Central Bank, remain hesitant to reduce rates given persistent price pressures stemming from oil and food costs. Inflation has also been particularly problematic in the Asia-Pacific region, as the Australian and New Zealand economies depend heavily upon commodity production. Moreover, the credit crunch that plagues the US and Europe has not been as severe in the region, and as a result, the Reserve Bank of Australia raised the cash target to an 11-year high of 7.00 percent in February. Though the Reserve Bank of New Zealand has not raised rates since July 2007, at 8.25 percent, their overnight cash rate is by far one of the highest among the developed nations. |
|
|
|
Clearly, interest rate differentials are not in favor of the US dollar, and the lower the Federal Reserve cuts the federal funds rate, the more likely traders are to sell the US currency against higher-yielders such as the Australian dollar, New Zealand dollar, and even the euro and British pound. If the greenback draws carry traders to the degree that the Japanese yen currently does, the constant selling pressure on the US dollar as the result of the carry flows will be a persistent weight on the value of the dollar. |
|
|
|
How Does the US Finance its Deficit? |
|
|
|
Until recently, deficits didn’t matter
Foreigners may pare their investments in the US
Fed may be caught between a rock and a hard place
Start of a vicious cycle |
|
|
|
The US current-account deficit has reached nearly $1 trillion per year. Typically, such staggeringly large financial obligations weigh on the country’s currency, but over the past several years, the current account deficit has not been a problem for the U.S. The United Sates has been able to attract at least $60-$70 billion in capital inflows every month to offset its monthly trade deficits of approximately $60 billion. Countries such as China, Japan, and the Persian Gulf nations of the Middle East have recycled their export profits back into US government bonds. This virtuous cycle was beneficial to all parties, as the financing helped to stimulate US consumer demand, which in turn has allowed those export-driven economies to sell Americans their goods. |
|
|
|
Unfortunately, the aforementioned virtuous cycle may be ending, only to be replaced by a vicious cycle. The Fed's persistent lowering of interest rates has diminished considerably the income received by foreigners on their US investments. In China, where the economy continues to grow at double-digit rates, the PBOC now losses more than $4 billion per month between the interest it must pay locally to attract deposits and the interest it receives on the nearly US$2 trillion of reserves it holds. |
|
|
|
Foreigners do not have to sell their current US reserves in order to hurt the dollar; they merely need to stop making additional purchases of US fixed-income assets. With no further demand for US financial assets, the demand for the US dollar will wane and the greenback will continue to fall. |
|
|
|
Dollar losses Its Reserve Status Supremacy |
|
|
|
Euro—a viable alternative
GCC—Dollar peg creates inflation
Rebalancing from 70% -30% to 65% -35% |
|
|
|
For the greater part of the 20th century, the dollar has enjoyed the enviable position of being the reserve currency for the world. That position created a natural demand for the greenback, as most key commodities from agriculture to energy to metals were denominated in dollars. At the start of the 21st century, however, the euro appeared on the scene, and because it is backed by an economy nearly as large as the US', it provided the first real alternative to the dollar. |
|
|
|
Recent price action in the pair has prompted many nations to reconsider their attachment to the US dollar, none more so than the oil exporting nations of the Persian Gulf. The GCC nations peg their currencies to the dollar, and the greenback's recent weakness has created massive inflation in their economy. The GCC makes most of its income in dollars from the sale of oil, but purchases more than 25% of its goods and services from the euro zone region. As a result of a much higher EUR/USD, prices have skyrocketed in the region to the point that many authorities in the region have started to debate the issue of de-pegging and even pricing oil in euros. The trend in the GCC reflects a much larger, more secular phenomenon of the erosion of the dollar's of influence in global trade and finance. Presently, most central banks hold a 70% USD to 30% EUR mix in their reserves. However, if the majority of the world’s central banks begin to rebalance that shift even by a relatively small percentage of 65% to 35%, such a move would unleash massive selling flows on the currency market and drive the dollar to even newer lows. |
|
|
|
Why Enhanced Dollar Index Programs from FXCM? |
|
|
|
Managed Accounts Provide Diversification, Eliminating Specific Currency Risk
In Careful Backtests Outperformed The Benchmark in Both Bull and Bear Markets
Amplifies Returns by Seeking to Earn Interest on Positions
Uses Proprietary FXCM Sentiment Data to Optimize Entries and Exits> |
|
|
|
Even if you are convinced that being a dollar bear could prove to be a profitable investment in 2008, why should you choose the Enhanced Dollar Index Programs from FXCM to express that point of view? One great reason is that this FXCM product provides all of the benefits of a broadly diversified index. Instead of being forced to guess whether the dollar will rally against the euro, the British pound, or the Japanese yen, the index serves as a weighted average of the key components and through diversification eliminates much of the individual currency risk. Many large banks publish their own versions of the dollar index, but most indices are just an academic exercise, not a real tradable instrument such as FXCM’s Enhanced Dollar-Bear Index Program. |
|
|
|
How does the FXCM Enhanced Dollar-Bear Index Program fare against dollar index products that are tradable, such as the famous DXY index on NYBOT? In carefully backtested results, the FXCM Enhanced Dollar-Bear Index reduced downside risks by losing less when the dollar rallied and amplified upside returns by gaining more than the benchmark during periods of decline. |
|
|
|
Dollar Bear Enchanced Managed Account |
|
|
|
 |
|
|
|
As you can see from the chart above, over the past five-year period—a time of extreme dollar weakness—the FXCM Enhanced Dollar-Bear Index significantly outperformed the DXY benchmark by registering far smaller losses. In 2005, the one year when the dollar rallied, the FXCM Enhanced Dollar-Bear Index only fell 7.71% against an 11.79% drop in the DXY.* |
|
|
|
How is FXCM's Enhanced Dollar-Bear Index able to achieve such stable and consistent outperformance over a relatively long period of time? The product relies on two important tools to help improve performance. First, the FXCM Enhanced Dollar-Bear Index uses carry- based strategies (whenever possible, the portfolio tries to hold interest positive positions, allowing it to collect interest payments every day) to enhance yield. Second, the FXCM Enhanced Dollar Bear Index relies on FXCM’s proprietary Speculative Sentiment Index indicator to optimize entries and exits. As one of the largest non-bank foreign exchange dealers in the world trading more than 100,000 accounts on FXCM trading platforms, FXCM is privy to the aggregate positioning of its traders. In the past, shifts in positioning signaling shifts in speculator sentiment have proven to be accurate signals for a turn in the price of the underlying currency pair. While past performance is no means a guarantee of future success, the FXCM Enhanced Dollar Bear Index stands as a time-tested, attractive strategy for those investors looking to long the dollar index while trying to outperform the benchmark. For those investors who want to consider the risk of a dollar long position, please read our report on the FXCM Enhanced Dollar-Bull Index. |
|
|
 |
|
|
*This claim is based on a comparison between the actual currency index and a retrospective, back-tested analysis of the FXCM Enhanced Index Programs during the relevant time period. Hypothetical performance results may have many inherent limitations, some of which are described in the risk warning. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.
One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk. Variables such as the ability to adhere to a particular trading program in spite of trading losses as well as maintaining adequate liquidity are material points that can adversely affect actual real trading results.
Please be advised that 1.5 leverage has been incorporated into the performance results displayed in the graph above. The performance presented in this graph also accounts for any interest charges that may have applied to the currency pairs shown. |
