The Next Two Months: Best Case, Medium Case, Worst Case

Author: Mac Slavo- April 29th, 2011
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David Galland put together an analysis worthy of your time where he discusses various viable scenarios we may see play out with the US dollar, stocks, commodities, and precious metals in coming months:

…given the current ill health of the dollar, I remain convinced that the Fed will pause in its blunt-force monetization, come June. And that is likely to provide a shot in the arm for the dollar – versus the equivalent of a shot in the head to the dollar, should they reverse themselves and attempt to continue monetizing at the same elevated levels, past June. Among other consequences, a rising dollar could spell trouble for overheated commodities, at least over the short term.

The big unknown, of course, is what will happen to U.S. Treasury rates. And for reasons discussed a moment ago, this is a really important unknown. We shouldn’t have to wait overly long for some answers. But while we wait, a few scenarios to ponder:

• Best Case: For a time, post-June the Fed becomes a relatively less important player at the Treasury auctions, buying about $17 billion in Treasuries, vs. the $100 billion or so they are buying now, and the market responds favorably to the policy shift. The gap left by the Fed is filled in by institutions, and by friendly governments, looking to roll back their diversification into the euro and the yen – given the poor outlook for both. For a while Treasury rates remain relatively stable. And that encourages the U.S. government to continue spending willy-nilly and keeps the party for equities continuing for awhile longer, albeit with the participants on edge and watching the exits for any movement.A rebound in the dollar, one result of an inflow of renewed foreign buying, would hit the commodities, causing them to underperform until it becomes obvious to all down the road that the Fed will have to once again begin monetizing.

• Medium Case: Post-June, participation at the Treasury auctions weakens, but not disastrously. Rates rise, but also not disastrously. The economy teeters on the edge, but doesn’t fall. Neither does the dollar rise overly much, and something akin to a twitchy status quo continues as people wait for the other shoe to drop, as it inevitably must given that the overarching problem of sovereign and household debt has not been resolved. Volatility in equities and commodities increases, but there is no sustained move one way or the other. Yet.

• Worst Case: Post-June, auction participation falls significantly, and interest rates begin to accelerate to the upside, sending equities markets into a tailspin, dragging commodities down with them. The Fed quickly reverses course and begins writing the big checks to the Treasury, stabilizing interest rates but sending shock waves through FX markets as the dollar hits the floor and discovers the floor is made of glass.The precious metals and other commodities soar. With nowhere else to run, investors begin bargain shopping for fallen equities – which are linked to tangible businesses, after all – and they bounce relatively quickly as well. Meanwhile, as the dollar collapses, the cost of everything begins to soar, crushing the unprepared and triggering real hardship. Unable to push interest rates higher to head off the price inflation, the Fed heads retreat to a hidden bunker and begin looking for friendly countries willing to give them sanctuary.
Of course, no one can see the future – but I think all three of those scenarios are likely to materialize in the relatively near future, one after the other from Best to Worst.

If I am right, then the way to play it is to expect a near-term rally in the dollar. While the U.S. dollar is toilet paper, it is of a better quality than the euro or the yen. Which is not to say that it doesn’t deserve its ultimate fate – the fate of all fiat currencies – but rather that, as long as the Fed shows some restraint here, it may be able to stave off that fate a bit longer.

Source: Silver Bear Cafe

With the second round of quantitative easing slated to come to an end in June, there may very well be a reprieve for the dollar – albeit for a short period.

We’ve maintained that any market crash or correction in equities, commodities and precious metals would likely have to occur as a result of upward pressure on the dollar. As Mr. Galland points out, the “bestâ€