Dear Reader, a funny thing happened on my way to Damascus - the US dollars in my pocket started vanishing. That rendez-vous with Ananias is on hold.

Exhibit 1: GBPUSD spot rate, 2002 to date (weekly data)


Apparently, during Thanksgiving this dollar-drop was “technical” and caused by thin volumes. However, since then the celebratory carve-up continues - although the dollar is still not trading below its December 2005 troughs of $1.956 (sterling) and $1.367 (euro). And, curiously, neither recent EU or US macro data have been clear-cut enough to account for the shifts underway.

Exhibit 2: EuroUSD spot rate, 2002 to date (weekly data)


Some reasons explaining why the dollar cannot fall significantly (as in much and persistently beyond those troughs) are around: logistically it is difficult for foreign central banks to diversify their fx holdings, whatever China announces; and, similarly, there are just not enough large liquid, stable equity/debt markets like the US into which surplus capital can be diverted.

This leaves only the broader global economy to put in context. As in the previous post, the bet is how deep will the US slowdown extend; and how far will it be offset by domestic demand elsewhere (both emerging and EU economies). Which is another way of asking is this all a helpful settling cyclical adjustment within a robust global economic expansion or reflective of a profound approaching US-led global slump.

Dollar action is, perhaps more than any concrete data can explain, beginning to play out trader sentiment between these two outcomes. But it is most probable upon the vast expanse of grey in between that the pendulum will come to rest.

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