I am working on a forthcoming longer piece, but I wanted to note now that it is my very strong belief that the US dollar is in the process of carving out a base against most developed and emerging market currencies (and that the lows are in many cases already in).
The US fundamentals certainly are extremely negative, as most people understand the meaning of fundamentals. Unfortunately that understanding tends to be oriented towards data that are (by the very definition of the word) given and backward-looking whereas markets at the beginning of a new trend incorporate possibilities that can only be dimly envisaged. Those market participants who entered the previous trend some time previously have gained wealth, renown and prestige from their participation; as the trend progresses ‘price makes news’ (as Peter Borish noted) and fundamental developments become known that seem to justify a continuation of the move to levels that one didn’t dare to whisper at the trend’s commencement; the physiology itself of these market participants changes as they rise in the pecking order– serotonin and testosterone levels rise, and the perception of danger ebbs.
Every market movement eventually reaches the end of its natural life – at this point the prestige of those in tune with the dying movement is at the highest it has been. At this point therefore, people have very little time to listen to those holding the opposing point of view. These people might have expressed a concern of increasing danger of a reversal rather earlier – they have had their say and been proven ‘wrong’ by the continuation of the old trend. Little consideration is given to the possibility that these arguments might in fact be correct, and that the persistence of the old trend represents an increased overshoot at a time of still-deteriorating fundamental support for the move.
I believe that one of the most educational experiences for a trader or investor in the first part of their career is to become a specialist in a small or illiquid market. The advantage of the sterling interest rate market, for example, is that there are very few houses providing liquidity in significant size and that even the exchange traded markets such as the gilt future and short sterling do not consistently offer large clients sufficiently liquidity to enter trades at the market. As a result. it is possible – if one has good relationships with marketmakers, and is an important client – to build up a very good picture of both the flows and the psychology driving market participants. I have noticed that although most investors pay lip service to the idea that sentiment and positioning matter, very few of them take it sufficiently seriously to try to assess these in an objective manner, let alone consider these factors as important drivers of the investment process. Yet based upon my experience in smaller markets I have found these to be tremendously valuable – it was this experience that inspired me to try to systematize my insights and apply them to other markets.
In that spirit, I post some items that may prove interesting with regards to the outlook today for the broad dollar.
Today (May 2011)
DXY (Dollar Index)