News Flash

US dollar to come under increasing pressure

20 Mar '09

6 min read

With interest rates already at zero and with no monetary reserves at hand, the only remaining option for the Fed is to print money in order to buy assets in the economy, with the hope to blow values back up. The scary part is that the Fed is probably not done printing money, because it will take a lot more to counterbalance the 40 trillion dollars of wealth destruction (30 trillion in stocks, 10 trillion in real estate) that the world has seen so far during this depression.

As a result of yesterday's Fed move, the dollar index suffered its worst single day loss in decades and the yield on the 10-year treasury fell by about 0.5% to 2.5%, the largest drop since 1962. Thanks to this unprecedented re-flation effort by the Fed and also some of the Asian and European Central Banks, commodities are now moving back into the limelight.

The logic is simple; all this money printing will sooner or later lead to runaway inflation and the debasement of paper currencies, and therefore a lot of the money that is currently parked in bonds or stuffed into mattresses will begin to look for investment vehicles. With stocks having horrible fundamentals and bonds offering more risk than reward from here on forward, commodities are an obvious choice for many investors, especially with prices as low as they are.

At the very least this Fed action is going to serve as a serious warning sign to short sellers, who may want to heed the advice to not fight the Fed. Therefore, even if we don't see a mad rush of new longs into commodities just yet, a rally could get triggered if shorts were to get scared and bailed out.

Open interest in futures has gone up by about 15'000 contracts over the last two weeks, which indicates that some new spec money has come in on the long side. So far there have been willing sellers, both among the trade and specs, taking the other side. However, since early February outright spec shorts have doubled from 2.3 to 4.6 million bales, as per the latest CFTC data. The question is what would happen if some of these spec shorts were suddenly spooked out of the market, be it because they rethink their position after the Fed's aggressive move or because some buy stops get triggered.

Who would be there to take their position? The trade net short position amounted to 4.4 million bales as of March 10 and while the trade has certainly some room to increase this short position in the case of a rally in order to lock in a favorable AWP spread, its bullets are limited these days. In other words, if specs shorts start to cover and new spec longs get established, it would be difficult for the trade to hold against that kind of buying and it probably wouldn't want to after last year's experience.

So where do we go from here? In the short-term the market may still struggle to get past the mid-40s based on the prevailing bearish fundamentals for cotton and we may even see a retest of the lows over the coming weeks. However, looking into the future we believe that this week's blunt Fed action is a game changer that will slowly but surely lead to a shift in market psychology. Inflation fears will become more pronounced and the US dollar will come under increasing pressure, which should underpin commodity prices.

Plexus Cotton Limited

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