Monday, September 12, 2011



The dollar might soar again. Three years ago, Lehman and AIG blew up. That led to a flight away from counterparty risk and a flight to quality. The US Dollar Index soared from a low of 71.99 during the summer of 2008 to a peak of 89.54 on March 4, 2009. During the first round of the European sovereign debt crisis, the index rose from 74.95 on November 30, 2009 to 88.71 on June 7, 2010. Signs of financial stress are mounting again, and could once again be bullish for the dollar. Let’s review:

(1) Foreign official and international accounts deposited $102.8 billion at the Fed, up sharply from $57.6 billion at the start of the year, and well above the previous high of $88.9 billion during the week of January 7, 2009.

(2) The flight to quality is most apparent in the plunge in 10-year government bond yields around the world to record lows. This morning these yields are at 0.92% in Switzerland, 1.00% in Japan, 1.66% in Sweden, 1.71% in Germany, 1.89% in the US, 2.11% in Canada, 2.19% in the UK, and 2.47% in France. On the other hand, yields are much higher among the credit-challenged governments of Spain (5.19%), Italy (5.44%), and Greece (18.56%).
 
(3) At the end of last week, the high yield spread in the US widened to 651bps from 416bps at the beginning of the year. It is the widest since November 30, 2009. This spread is an excellent leading economic indicator and suggests that the outlook is deteriorating.


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