Tuesday, June 10, 2008

On the Other Hand, is a Big Rally Forthcoming?

There is a scenario that has a low but reasonable chance of occurring next week that could result in a very large rebound in share prices and risk assets next week and the week after, say 500 points or so in the Dow.

If the G-8 delivers a communiqué strong enough to reinforce the recent message on the dollar, and if OPEC's meeting with consumers results in more oil production, the combination could boost the value of the dollar, jolt the commodities markets, and thus bring a huge sigh of relief to investors. U.S. Treasury Secretary Paulson has resisted opportunities like this before, particularly following the April 11 G-7 meeting, which produced a communiqué that French Finance Minister Lagarde said was on par in importance with the 1985 Plaza Accord. Any effort to boost the dollar would be welcome worldwide, given the recent surge in commodity prices. Massive intervention would cap it off.

I recognize that governments are powerless against the markets (the currency market sees daily volume of $3 trillion) and that currency values are set by fundamentals, but there are times when leadership, guidance and hand-holding are needed in the financial markets. Combining short-run strategies such as this with long-term strategies can be effective, as seen recently in the Federal Reserve's adoption of liquidity provisions as a short-term strategy and use of the fed funds rate as a long-term strategy.

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