Tracking the causes of the commodities crash is starting to feel like peeling an onion.
One layer gets pulled back only to reveal another, and then another — and then you start to cry. Last week we had UBS analysts blaming “extreme positioning short the dollar and long commodities.”
So peeling back another layer, you might ask, what triggered the dollar rally?
Here’s a thought from Barclays Capital — about Asian intervention:
Most emerging markets have reported data for official foreign exchange reserves for April. Intervention appears to have been large in April – rivaling that of autumn 2010 – as the USD faced strong downward pressure during the month. However, as happened last autumn, large intervention has been followed by broad USD strength. Thus far in May, the USD is up against all G10 currencies (except for the JPY), and most emerging market currencies as well, and the Barclays Capital USD nominal effective exchange rate is up 2.3%, the same appreciation as in the two weeks after the announcement of QE2. Intervention on April’s scale effectively absorbs excessive amounts of USD from the market, setting it up for rallies in response to shocks (such as the emergence of concerns over Greece). Conceivably, the large intervention may help explain the US Treasury rally, while also creating a “portfolio balance effect” for equities.
April intervention appears to have exceeded USD100bn for the set of emerging markets we track …To estimate intervention, we start with the change in reported foreign currency reserves, subtract changes due to currency valuation effects, and subtract estimated coupon payments on bond holdings (which we assume are reinvested), based on foreign official holdings of US Treasuries. April data on forwards, which certain countries use to intervene, are not available for many countries, but would likely add to the total. In terms of the regional breakdown, Asia (especially outside of China) and emerging Europe recorded their largest totals since spring 2010. Latin American intervention declined, reflecting a sharp fall-off from Brazil and Chile.
What effect does intervention have on the USD? In the short run, intervention moderates the USD’s decline, and in the long run, it provides support for the USD – not only against the countries that intervene, but more broadly, as well. Intervention under tightly managed exchange rates effectively ships excess savings to the US, easing the financing of US external deficits and limiting the need for USD depreciation in general. Simply put, it supports the USD against the G10 currencies (see FX Focus: CNY strength, broad USD weakness, April 21, 2011).
In the short run, though, excessive intervention can succeed all too well: USD is withdrawn from the market, leaving the USD prone to notable rallies if news or events turn less USD negative. For example, in the run-up to QE2 in August-September 2010, intervention totaled about USD300bn – or about 2.5x the size of the US current account deficit. When the US current account deficit began to contract in the fourth quarter, the market was effectively left short USD, setting the stage for a USD rally when the size of QE2 was smaller than many expected and the crisis in Ireland intensified. The same thing has happened recently. In April 2011, total EM intervention was about 2.5x the current account deficit on an annualized basis. The US current account deficit has likely widened recently, but not as much as the increase in intervention.
As BarCap also note, dollar rallies based on pure positioning tend to be short-lived — you need positive economic indicators to really keep them going. Just two weeks after the commods rout, these haven’t been forthcoming. BNP Paribas’ currency team says on Thursday that a more recent commodities bounce, combined with some renewed US debt ceiling concern, is now driving the dollar lower.
Related links:
The ‘Asia connection’ to the commodity rout – FT Alphaville
UBS on the commods crash – and getting ready for the next one - FT Alphaville
Deutsche chimes in on the commodities rout — it’s the QEnding – FT Alphaville