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King Dollar Is Dead: Long Live the King!


ZIRP may become an idea whose time has come and gone.

On September 13, 2012, Bloomberg reported:

The Fed said it will continue its program to swap $667 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, an action dubbed Operation Twist. The central bank will also continue reinvesting its portfolio of maturing housing debt into agency mortgage- backed securities.

Richmond Fed President Jeffrey Lacker dissented for the sixth consecutive meeting, saying he opposed additional asset purchases. Lacker opposed the FOMC's June decision to extend Operation Twist through the end of the year and has said he expects interest rates will need to be raised in 2013.

The 10-Year Treasury Note Yield Index ($TNX) (INDEXNYSEGIS:AXTEN) is not behaving the way one would expect after Ben Bernanke announced his intent to purchase $40 billion of mortgage-backed securities (MBS) per month. His announcement may have temporarily stemmed the rise in yields just under their trendline. However, yields have not yet begun to reverse lower. Two potential reasons for this behavior are (1) bond investors may see rising inflation eroding their future returns; or (2) there may be an element of rising risk, even in the bond market.

Bloomberg/Business Week reports, "Thirty-five percent of global investors listed the so-called fiscal cliff, which may prompt more than $600 billion in spending cuts and tax increases unless Congress acts, as the biggest risk. That exceeds the 33% who are most concerned with Europe's sovereign-debt crisis, according to the BofA/ Merrill Lynch Fund Manager Survey for this month."

Does this portend the death of the US dollar? We think not!

The decline in the US dollar has stopped almost precisely at its weekly mid-cycle support. This constitutes less than a 50% retracement of the year-long rally that began on May 2, 2011. The bond market already knows this. Historically, the Fed funds rate has followed the 90-day T-Bill rate. T-Bill rates are already higher than the pre-crash scenario in July 2011.

This could very well be signaling that a crisis is at hand, with higher yields to come. If so, ZIRP may become an idea whose time has come and gone. If this is the case, we can expect that the US dollar will rally. If this happens, all those who have proclaimed that the US dollar is dead may be forced to reconsider their position.

See more from Anthony M. Cherniawski at The Practical Investor, and more from Janice Dorn, M.D., Ph.D. at Trading With Art and Science.
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