Finding Opportunity In Market Disconnects — What I’m Looking At Now

  • January 22, 2004
  • Yra Harris

  • Revisiting the concept that jawboning
    the markets is at best a short term success: markets turn on policy
    change, not rhetoric.

     

  • Canadian officials try to stem the
    recent currency strength by action – they cut interest rates as a
    policy too/and although currency is still strong it has eased relative
    to other G-7 currencies.

     

  • Examining a market disconnect. 
    Question:  If the U.S. dollar is so fundamentally weak, why have
    U.S. government debt instruments out performed European government
    debt?

The World Economic Forum in Davos 
is in full session and the rhetoric will be in full spin.  From
corporate chieftains to political potentates, the talk will involve
the dollar.  The twin deficits of the U.S. are causing
dislocations that stand to disrupt the current global recovery. 
Every shaman within distance of a microphone or camera will have an
opinion and the sycophants of mass media will dutifully report the
“news”.  European Bank Chief Trichet will in his typically
arrogant fashion try to jawbone the dollar higher as he will remember
his success of last week.  This time he will fail as the market
had a needed correction but will now press new highs. The world will
not get dollar support from any U.S. official as this is a political
year and a weak dollar is a policy tool of the U.S. administration. 
Only a dramatic fall in the dollar that creates a sell-off in the U.S.
bond and equity markets will prompt a U.S. response.  Jawbone all
you want but without concentrated action, all corrections in the
dollar will be short lived.

The noise out of Canada for the past
few days has been how the strength in the Canadian $ has begun to bite
into the recent strength of the Canadian economy.  Although
strong against the U.S. $ the Canadian dollar has actually weakened
against the other G-7 currencies.  The Canadian has violated
several of the longer term moving averages of the Canadian cross-rates
(i.e. Canada/Euro, Aussie/Canada, Sterling/Canada).  But the
Canadian authorities are much more concerned about the U.S.dollar
because the greatest part of their export trade is with the United
States.  Rather than jawboning, the Canadians took action and cut
their interest rates which has for the moment arrested the
appreciation of the Canadian currency.  Will this policy have
continued success?  I for one doubt it as the underlying
fundamentals of Canada are very favorable.  The new Prime
Minister, Paul Martin, is in my opinion, the most economically
knowledgeable head of state in the world. The Canadian economic turn
around can be credited to him when he was Finance Minister.  If
the Canadian economy were to slow because of a strong currency Mr.
Martin would probably move to cut taxes–the Canadian economy has
“twin surpluses” so has the room to be aggressive on tax reform. 
On a major correction I would certainly look to be long this currency.

To quote the great Dostoyevsky,
sometimes 2 + 2 = 5 is also a beautiful thing.  As a trader I
look to find opportunity in market disconnects.  We had the
chance 10 days ago when the market could not hold the unemployment low
made in Euro currency.  Like Dostoyevsky, finding pleasure in the
irrational can be nirvana for a trader.  I believe that global
interest rate markets are setting-up for such an event. 
Rationally, the U.S. long interest rates cannot keep out performing
other global instruments if the dollar is so inherently bad — if you
don’t want the currency why would you want the debt?  If you want
me to own a diminishing asset you have to pay me more, not less. 
U.S. long rates continue to fall while the Dollar declines creating a
major disconnect.  What is probably happening is that the major
buying of U.S. debt by Asian governments is causing a major disconnect
in the interest rate market that cannot continue forever. 
Something eventually has to give and that will provide great trading
opportunities in currency and interest rates.  How long this will
continue I don’t know, but I would say that traders should watch the
yield spreads between U.S. rates and other G-7 government debt. 
If this spread starts to reverse from its present action it will be
indicative of something dramatic to come.

Stay focused and disciplined,

Yra Harris

yra53@aol.com

P.S.  I am going skiing so I will not correspond until
Wednesday of next week.