Interest Rate Roundup

Wednesday, March 12, 2008

Dollar rumblings in the Middle East

Most of the post-Fed moves (big rally in stocks, big surge in 2-year yields, etc.) have largely stuck, with a little bit of giveback. But the one glaring exception is the U.S. dollar. The Dollar Index (DXY) staged a rally after the Fed plan was announced ... but it has largely given up those gains today. In fact, the Dollar Index touched 72.47 today, its pre-Fed low yesterday. The euro currency also set a marginal new high.

What gives? Several forces, but a key source of weakness appears to be rumblings in the Middle East about dollar pegs. Many regional currencies, including the UAE dirham and the Qatari riyal, are pegged to the U.S. dollar at fixed exchange rates. The problem is, having a dollar peg in your country essentially links your monetary policy to the U.S.'s monetary policy. If the U.S. Fed cuts rates to stimulate the U.S. economy, your economy will be stimulated as well -- even if the LAST thing you need is an extra boost. And believe me, most economies in the Middle East don't need it -- after all, they're raking in billions and billions of dollars from oil sales.

The result of the Fed-provided stimulation ... on top of strong regional economic growth ... is a gigantic inflation problem in many Gulf countries. UAE inflation surged to a record high 9.8% last year, according to estimates, up from 9.3% a year earlier. The government is planning to cap certain food prices and considering building up a "strategic food reserve" in response. In Qatar, inflation is exploding higher at a 13.7% rate, prompting countermeasures such as rent caps.

A publication called Emirates Business 24/7 reported that six Gulf nations are going to meet in a few days to discuss regional dollar pegs. Qatar came out today to deny that it was a currency revaluation-focused meeting. But based on trading in the dollar today, the market looks a bit skeptical.

UPDATE: The DXY was recently off 1.19%, its biggest single-day loss since January 3, 2006. Long bond futures were recently up two points in price. That's a 1.69% upside move, the biggest rally going all way back to August 6, 2004 (also +1.69%). Wow.


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