FOMC Meeting - Time for a Dollar Collapse?

Later today the Federal Reserve's Open Market Committee will announce its decision on US interest rates. Many are expecting another half a percentage point cut, bringing the discount rate down to 1%. What effect will this have on the dollar?

We have seen the dollar rally spectacularly in the last couple of months from an all-time low of the dollar index. However, this has been largely due to the fall in the Euro and Sterling, which account for a majority of the dollar index. The dollar has actually fallen against the yen.

Now, the media pundits are nothing if not cliche-merchants, and the mantra has been that the resurgent dollar is due to a "flight to quality". Quality!? With so much dollar wealth being destroyed it seems a flight of fancy to see the remaining dollars as quality. And at potentially just a 1% yield that seems very poor value - OK 30-year treasuries are still around 3%, an indication that the market doesn't see such low rates lasting for long.

But that is partly the point, at 1% there is very little lower it can go. What this also means is that bond prices - treasuries - cannot go much higher (unless the US has a credit downgrade). So by the end of today we could see treasury yields at their lowest and their bond prices at their near-term highest. If I was a foreigner holding billions of dollars worth of treasuries, this looks like a good time to get rid of them.

One thing that seems to be being forgotten is that a huge amount of US debt is in the hands of foreigners, both corporations and foreign government sovereign funds. This rise in the dollar seems to me to have little to do with quality and everything to do with corporations needing to liquidate assets in order to buy dollars so they can keep afloat as credit is expensive or non-existent. As has been noted elsewhere, this is not a flight to quality but a concerted repatriation of global dollar assets. This is a flight to self-security! However, what happens when other governments, dragged down by the US mess, decide that it is in their own self-interest to repatriate their own foreign investments?

The decisions of the inner sanctum of central bankers may well be a mystery to most of us. The manipulations are evident but in whose interest is often less so. However, if Americans are being bounced into repatriating assets, then everybody else in the world can do the same. Once treasury bonds have maxed out, what is the point in holding them? Indeed, with the combination of the dollar rally and bonds rising, many foreigners are holding onto very large profits from the last couple of months. What will happen when those profits are taken? What will happen when other countries start doing the same as the USA?

The markets are currently predictably unpredictable. But I for one will be keeping one eye on currencies, one eye on treasuries and the other on the stock markets. I know, it's not easy!


Also posted at Xomba