Why The Dollar Drops on Good Economic News
I have been asked repeatedly why the dollar is dropping on good U.S. economic news.
In a U.S.-centric world, positive U.S. economic data would indeed be dollar-positive.
But we don't live in a U.S.-centric world any more, we live in a global world.
In this world, the U.S. is the weakest leak in the chain, with Asia strongest, Europe second, and the U.S. taking up the rear.
Positive U.S. economic data gives global players confidence that the laggard is turning around and the worst of the global recession is behind us.
This means it is safe to play the risk trade: short dollar/long commodities/long emerging markets.
Why this trade? Because participants believe emerging markets is where the growth is, and they will use the U.S. dollar as a funding mechanism to buy higher-yielding assets abroad, just as the yen was used as a funding mechanism in the last decade.
That doesn't mean that a perpetually weakening dollar is good for the U.S.: it isn't. But that's a different story.
Elsewhere...Inventory restocking: stop me if you've heard this one before....
Now that we have settled the question of when the recession ended (some time this summer), traders are debating how much growth we can get in 2010.
One big issue: inventory restocking. Remember this one? Bulls have argued that inventories were being drawn down so quickly that eventually there will need to be a dramatic "restocking" to replenish supplies.
OK, so where is it? Inventories were drawn down by $131 billion in Q3, following drawdowns of $160 billion in Q2 and $114 billion in Q1. Why are inventory drawdowns still so large? Because corporations are still not restocking!
This is good news and bad news: bad news because we still don't see restocking (bulls thought we would by now) and good news because bulls are saying: Q4 will see it!
Questions? Comments? firstname.lastname@example.org