The dollar was crushed yesterday. The
U.S. Dollar Index dropped more than 2%, reversing whatever gains were left
from the now-evaporated summer rally.
The verdict, it would seem, is in. The forex market isn't amused by the
prospect of adding $700 billion-plus to the already bloated U.S. budget deficit.
Jay Bryson, global economist at Wachovia Securities, summed it up neatly in a
note to clients yesterday, explaining that "this weekend’s announcement that
the U.S. government will buy up to $700 billion worth of bad debt from financial
institutions is a short-term negative for the dollar. In order for investors to
absorb the increased issuance of U.S. Treasury securities the returns on those
securities will need to rise."
Bryson adds that there are two ways for bond returns to rise from a foreign
investor's perspective. Yields can rise, which is to say that prices will drop.
That seems plausible, given that $700 billion in new debt equates to roughly 15%
of existing Treasury debt outstanding. The second way is a depreciation of the
dollar.
Yesterday, we got both. The buck was slammed and the benchmark 10-year
Treasury Note rose to 3.83%, the highest close in more than a month.
Why does this matter? Because foreigners will be ponying up a fair chunk of
the $700 billion loan to fund the new bailout plan. As such, monitoring what
foreigners think is more than a passing news story these days. One might wonder
what might compel foreign central banks and offshore investors to further expand
their already large holdings of Treasuries.
But all is not lost for dollar bulls. Some of the fall yesterday was a
reflection that there are still lots of unknowns about when Congress will
greenlight the money, and what the terms will be. As those gray areas lift, and
if the market takes a shine to the details, the greenback may rebound.
Nonetheless, forex risk has jumped sharply in recent days. The U.S. was
already tending a hefty batch of red ink before the events of the past few
weeks. The federal government was in the hole for $162 billion for fiscal year
2007, according to the Congressional Budget Office. The good news: that's
smallest pile of debt since FY2002's $158 billion. It's also the smallest share
of U.S. GDP since FY2002 as well.
The challenge isn't looking backward, however. It's the future.
