Is the ‘recovery’ back on track?

There has been a lot of double-dip talk in the market, and a lot of it from us. But, we remain open to being very wrong. Quite possibly, if the recovery is back on track, the US dollar will get smoked on yield and growth differentials; a couple of key factors that not too long ago appeared to favor Mr. Greenback.

From Morgan Stanley’s Richard Berner and David Greenlaw on the double-dip myths:

“In our view, three myths pervade current negative thinking about the outlook. One is that the ‘sugar high’ from fiscal stimulus is over; now it’s payback time. In our view, fiscal thrust – measured by the change in the standardized deficit/GDP – is peaking and probably will decline in the second half. But the impact of fiscal policy lags behind and is still supportive of growth, especially through stepped-up infrastructure outlays.

“…A second myth is that the inventory ‘cycle’ has run its course. In fact, we see inventories getting leaner in relation to sales by the day. Excluding motor vehicles, the real manufacturing and trade I/S ratio in April declined to 1.28 months, not far from all-time lows.

“…A third myth: The fast-growing EM economies are too small and fragile to provide a material boost to US exports, and rising US imports will swamp any gains. In contrast, we think strong growth in domestic demand in the larger EM economies in Asia and Latin America will promote strong gains in exports.

US Merchandise Exports SA Monthly:

There seems a justified growing expectation the US Federal Reserve will keep the spigots wide open and play the Quantitative Easing game even longer. If we couple that with the idea the recovery is back on track, it points to another bout of US using the dollar as global liquidity toilet paper, in effect.

On a relative basis, compared to Germany, US short-term yields have turned over sharply, as you can see in the comparison of US-German 6-month benchmark yields below:

Take a look at the yield differential chart above, then compare it to the US $ Index chart below, you may see a similarity:

So, is this a setup for a deeper “correction” in the US dollar—more than most (including us) originally believed?

Yes seems the short answer.

We know there is massive exposure within the European banking system. We think the “stress tests” will be a
public relations exercise, to a large degree. And we know investors choose to believe what they want to believe—perception trumps reality in markets. So despite our longer term view the euro is toast, just maybe it shakes up the new dollar bulls for a few weeks or so on the “recovery back on track” theme.

Good news on jobs in Australia, and Canada this morning, provides excellent raw material for the recoverytheme. But then again, it is rearview mirror stuff and we can never underestimate the ability of the Eurozone systemic risk to come rushing back at any moment and spoil all this recovery cheer once and for all. Hmmm….it never seems to be easy.

Stay tuned.

Jack Crooks
Black Swan Capital
www.blackswantrading.com

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