What can spark a USD rebound in the short term?

October 13th, 2009

Share |

Back in April last year, we wrote in What if the US fall into hyperinflation?, countries like China, Middle East and Russia will be taking two-pronged action:

1. Slowly and quietly diversify away their US dollar reserves. Obviously, none of these countries will be doing so while talking about it with their megaphones- the US dollar will crash straight away if they act so foolishly.

2. Since there is so much to lose from a collapsing US dollar, we can be sure that central bankers around the world are collaborating together to avert a sudden loss of confidence in the US dollar. If possible, they may even want to engineer a rise.

The first point is old news. Blogs and the mainstream media have reported on that extensively (e.g. US dollar rout gains momentum). Everyone knows that. The strong down-trend in the US dollar is testament to the fact that the majority are shorting the US dollar. The carry trade that we wrote in Return (and potential crash) of the great Aussie carry trade is an example of such.

The problem with the first point is that given the strong down-trend of the US dollar, foreign central bankers must be getting worried that selling of the US dollar can eventually become a ‘bubble,’ which implies a crash in the US dollar. Therefore, we can expect that something will be done sooner or later in the name of ‘preserving’ their export trade. It is time to be on alert for a short-term US dollar rebound, which is likely to be coupled with falling stock prices (see Indicator turned bearish despite high in index) and falling gold prices. Indeed, this little news article has been reported in the Financial Times:

Asian central banks intervened heavily in the currency markets on Thursday to stem the appreciation of their currencies against the US dollar amid fears that their exports could be losing ground against China.

The mainly south-east Asian countries have been spurred to defend the competitiveness of their currencies by China?s decision to in effect re-peg the renminbi to the dollar since July last year.

The question is whether these currency interventions will be coordinated or haphazard among the central bankers. But we can be sure that interventions will increase as the rout of the US dollar continues.

But make no mistake about this: in the long run, the US dollar will weaken.