|
Reasons for a Major Turn in the US Dollar
FXCM Enhanced Index Programs |
|
|
|
|
|
|
|
|
While the Dollar Index hits multi-decade lows and as the euro continues to trade within striking distance of record highs, savvy investors are beginning to wonder if the current market conditions present a unique opportunity to buy the US currency at ultra-cheap levels. However, with the Federal Reserve aggressively cutting rates and talk of an oncoming US recession dominating the airwaves, investors are understandably concerned about buying the beleaguered buck at this time |
|
|
|
Here are a few reasons why being a dollar-bull may be a good idea this year, even if the United States experiences a serious economic slowdown: |
|
|
|
 Dollar near all-time lows |
|
Bargain opportunity? |
|
| Fed ahead of the curve everyone else is behind |
|
Will the dollar outperform? |
|
| Lower US Interest Rates and a stimulus plan |
|
US economic rebound and a resurgence of the dollar? |
|
| Lower dollar |
|
Better US corporate profits, improvement in trade deficit? |
|
| Deep US recession |
|
Dollar becomes a safe-haven play? |
|
|
|
|
The Federal Reserve is Ahead of the Curve … |
|
 Fed lowers the cost of capital by 40% in just
6 months
Makes adjustable rate mortgages more
affordable |
|
| 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 was not in such terrible trouble? |
|
|
|
Dollar Index Through 1998-2008 |
|
 |
|
|
|
|
|
When the subprime crisis became front-page news in August 2007, the Federal Reserve responded quickly to the growing problems in the credit markets. It dropped the discount rate by 50bp to 5.75% and provided liquidity to the banks through its open market operations. Other central banks followed a similar path, but the Fed was the first major central bank to take the easing process a step further by lowering the Fed funds rate a full 50bp in September. Then, while other central banks debated the merits of lowering rates or staying put, the Fed did not hesitate and continued to ease aggressively by cutting rates another 50bp in December and then a whopping 75bp in January. Altogether, the Fed reduced rates by 175bp in just six months and dropped the Fed Funds rate from 5% to 3%, providing a near 40% reduction in the cost of short-term capital for the US banking system. |
|
|
|
While Everyone Else is Behind It |
|
|
|
ECB stubbornness could lead to a severe contraction in Europe later in the year
BoE already forced to lower rates
As easing accelerates, European currencies lose their principal advantage of higher
interest rates |
|
|
|
In contrast to the Fed, other central banks have been very slow to act; EU and UK monetary officials proved to be much less responsive to the crisis. The Bank of England stubbornly refused to boost liquidity; consequently, within a few months, Sterling Libor rates (the rates which banks charge each other for overnight loans) spiked higher amidst the rapidly tightening credit conditions, forcing the Monetary Policy Committee to begrudgingly reduce interest rates by 25bp in December and by another 25bp in February 2008. In the meantime, while the European Central Bank did move quickly to add liquidity to the system by temporarily loaning funds to banks, they left the rates unchanged at 4.00%, providing no help to businesses. |
|
|
|
Meanwhile, reports in both the areas have started to signal a significant deterioration of economic conditions. With global growth anticipated to slow further this year, these cracks could turn into canyons, which may force the Bank of England and European Central Bank to make up for lost time and slash rates much more aggressively in the second half of 2008. Should that be the case, both currencies would lose their attractiveness as their yields quickly decline. Meanwhile, the dollar should rally as speculators and investors dump euros and pounds. In short, while most of the bad news is already priced into the dollar, the markets may be underestimating the potential risks to other advanced economies. Currencies are always a relative bet, and the dollar can appreciate, even in a challenging economic environment if its trading partners are faring worse. |
|
|
|
Lower US interest rates + stimulus plan = US economic rebound? |
|
|
|
Fed easing stabilizes the housing market
US consumer boosted by stimulus package
US economy merely slows, does not contract
No need for additional rate cuts |
|
|
Whether you want to call it a "panic response" or an aggressive attempt to lessen the blow of an oncoming recession, the Federal Reserve's rapid rate cuts should provide some soothing relief for the US economy. First, while the massive correction in the housing market is not over yet, mortgage holders may get some respite from their mortgages as interest rates ease and the government, in conjunction with mortgage lenders, offers 30-day freezes on foreclosures, allowing borrowers to modify their loans in order to make them affordable. If the Federal Reserve and the US government can curtail the growing number of foreclosures, it could help stabilize the housing sector and remove one of the biggest headwinds to US economic growth. |
|
|
|
Meanwhile, an economic stimulus plan will start to pay out as early as May, with many taxpayers receiving a rebate of between $600-1200. The hope of Congress and the Bush Administration is that the money will boost consumer spending and help rejuvenate the services sector. The plan also includes adjustments that will allow small businesses to expense, rather than depreciate certain asset purchases. As a result, businesses will be more likely to keep their workers, exerting less pressure on the unemployment rolls. |
|
|
|
While these policy initiatives won't necessarily work wonders overnight, they may greatly reduce the risk of a full-blown US recession. With markets already pricing in a doomsday scenario for the US economy, any evidence of growth—even if it's relatively modest—will be viewed positively by the currency market and could lead the dollar to rebound while investor sentiment improves. |
|
|
|
Big businesses benefiting from a weak US dollar may actually be a boost for the currency |
|
|
|
US multi-nationals benefit from lower dollar, profits surprise to the upside
US stock markets bounce as a result attracting foreign investment and demand for the
dollar
US trade balance improves as exports boom, contributing to growth |
|
|
The tax code changes included in the US government's economic stimulus plan are geared towards consumers and small businesses, but what about large multi-national corporations that bring in millions of dollars in profits and hire thousands of workers each year?
These firms are already getting some help in the form of the weak US dollar.
| The decline in the currency has turned US-made goods into relatively cheap products compared to those from the euro zone or UK. For example, the US-based aircraft giant, Boeing, beat out Europe's Airbus in orders during 2007. If the market for aircraft isn't as fertile as it was in 2007, these companies will likely be forced to be even more competitive in 2008, and the low exchange values could provide US corporations with a crucial edge in winning more business. This dynamic is not only good for the domestic economy, but it is also positive for the US trade deficit and
stock market. If investors from abroad decide to buy up stock in US corporations, the influx of capital into the U.S. will actually end up helping the greenback structurally as the US trade deficit contracts and US investment flows expand. |
|
| US Trade Balance from 2002-2008 |
 |
|
|
|
|
Could Recession be a Boon for the Buck? |
|
|
|
Paradoxically, worst-case scenario for the US economy could be positive for the dollar
Global economic slowdown will lead to liquidation of risky assets
Demand for US treasury bills and bonds will soar
Dollar will benefit as safe-haven repository |
|
|
As we mentioned above, capital flows into US assets can provide a boost to the dollar from a supply/demand point of view, but the greenback can gain even under the worst-case scenario of a severe US economic recession. Presently, global central banks are worried about the stability of the financial markets, leaving investors concerned as well, which is why we've seen waves of risk aversion sweep through the financial markets. If conditions become worse—be it from a major corporate or government default, or some sort of systematic failure—there is little doubt that global financial markets will become panicked and turn volatile once again. Subsequently, investors will flee to safe haven assets, and US Treasuries tend to benefit greatly during such times. If the shift in funds is large enough, the surge in demand may quickly boost the value of Treasuries, and therefore US dollars as investors flock to safety. Paradoxically enough, in times of trouble, the dollar is likely to stand as the currency of last resort and therefore, even if you are not bullish on the prospects of the U.S. or global economy, you may still want to be long dollars. |
|
|
|
Why Enhanced Dollar Index Programs from FXCM? |
|
|
Managed accounts provide diversification, eliminating specific currency risk
In careful backtests the Programs 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 bull 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, it 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 Index Programs |
|
|
|
How does the FXCM Dollar-Bull Index Program fare against other dollar index products that are tradable, such as the famous DXY index on NYBOT? In carefully backtested results, FXCM's Enhanced Dollar-Bull Index Program reduced downside risks by losing less during periods of decline and amplified upside returns by gaining more than the benchmark when the dollar rallied. |
|
|
|
Enhanced Dollar-Bull Index Program* |
|
 |
|
|
|
As you can see from the chart above, over the past five-year period—a time of extreme dollar weakness—the FXCM Enhanced Dollar-Bull Index significantly outperformed the DXY benchmark by registering far smaller losses. In 2005, the one year when the dollar rallied, the FXCM Enhanced Dollar Bull Index rose 22.58% compared to a rise of only 11.79% in the DXY.* |
|
|
|
How is the FXCM Enhanced Dollar Bull 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, FXCM's Enhanced Dollar-Bull 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, FXCM's Enhanced Dollar-Bull 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, FXCM's Enhanced Dollar-Bull 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 short position please read our report on the FXCM Enhanced Dollar-Bear 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. |
