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Foreign Exchange

Axel Merk: Black swan event not needed for a dollar crash

Currency traders should not be lulled into a false sense of security regarding the US dollar’s recent appreciation, warns Axel Merk, CEO of Merk Investments.

“For many years, until a month ago, the European Central Bank, in its monthly communiqué, warned of a ‘potential for a disorderly correction of global imbalances’,” says Merk. “That was central bank parlance for a dollar crash. “What many don’t realize is that we don’t need a low probability, high-risk event – a black swan event – to be concerned.”

He says a sustained sell-off in US Treasuries might force foreign investor outflows that could send the dollar tumbling.

Rising yields in the US treasury market and the positive effect this has had on the dollar has become the topic du jour in the markets. In less than a month, the US 30-year bond has lost about 8.5% in value and, at the same time, the dollar has been the best-performing currency.

While some pundits point out that falling bond prices make the dollar more attractive as yields are higher, that is little consolidation to those holding Treasuries, a large proportion of which are from outside the US, says Merk.

Indeed, the latest TIC data show that in January net foreign investment into US Treasures was $101 billion versus an expected $38.5 billion.

“It turns out that foreigners appear to have piled into longer-dated Treasuries just before the recent correction, possibly making for a few very unhappy, but very important, investors,” he says.

Some analysts have said the recent sell-off has come from a tactical move from the short-term community rather than a structural shift away from Treasuries coming from real money, but the emergence of a Treasury bear market could cause foreign investors to liquidate their bond holdings.

If these funds were repatriated or invested in non-dollar-denominated securities, then the dollar would weaken.

“Historically speaking, our analysis indicates that the US dollar tends to weaken during early and mid phases of an increasing interest rate cycle,” says Merk.

“That’s precisely because the bond market turns into a bear market in such an environment.”

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