We're setting up to see some pretty big volatility in the upcoming week... Towards the end of last week, we really witnessed the yen begin to lose steam... And, many traders are struggling to find a reason supporting cross currency strength... Here's the thing, really, there's not too much "flight to safety" reasoning behind the yen today, nor was there yesterday. In fact, the "flight to safety" reasoning is really more psychological than anything else.
Here's what you WON'T read anywhere else but here... While the rest of the world is trying to figure out why the yen has come under weakness, the reasoning is truly the potential deterioration in the credit quality of U.S. Treasuries.
See, it is a fundamental principal in economics that anytime you increase the money supply, inflation kicks in. Right now, the market is pricing in deflation. But there's more to the story. Three weeks ago, in the U.S. Treasuries $30 billion auction, there were no buyers of U.S. debt. Mysteriously an anonymous bid stepped in to save the day...
Just read this excerpt from James West, "Last Thursday, an $30 billion auction in five-year notes failed to stir the interest of traditional primary dealers. The auction itself was saved by an anonymous "indirect" bid.
Buyers are discouraged by the prospect of what is expected to amount to $2 trillion total issuance for the full year of 2009. The further out the maturities on notes, the more bearish the sentiment towards them. The only way to entice buyers is through the increase in yields."
See, the stimulus plan, coupled with the trillions the U.S. Treasury now thinks it will magically find for the TALF program has "smart money" realizing that the U.S. simply cannot take on this much debt and reasonably assume that it will not see the credit quality of Treasuries deteriorate. Fact is, when buyers stop showing up to the Fed auctions, the Federal Reserve will have to buy its own Treasuries, thus raising interest rates, while seeing the dollar fall through the floor.
First, the yen will go... Why? Because Japan is the second largest holder of U.S. Treasuries, next to China. The smart money is already exiting yen positions, because when Japan gets left holding the bag (China's currency is pegged, at least...for the most part), funds, banks and currency reserves don't want to be stuck holding the yen (read: U.S. Treasuries.) Second, the U.S. Dollar could then begin to fall, as traders infer the Federal Reserve will have to yank interest rates through the roof to attract buyers. (Call it Treasury junk status, if you will.)
At the end of the day, the dollar is in DANGEROUS territory because of the irresponsible spending habits of Congress, Senate, the Presidential Administration, the Federal Reserve and the U.S. Treasury.
Gold will be the proof of the pudding, as new highs will show that major money doesn't want to be anywhere near traditional flight to safety currencies like the U.S. Dollar, or the yen.
Anyway, we could see a rebound in other currencies in the mean time, like the pound, euro, aussi and kiwi.
Exit is everything,
Mark Whistler
FXVolatility.com
WallStreetRockStar.com