Portfolio Performance : +34.78%

US Dollar Barometer stands at +3

Trade Recommendation : Long USD/JPY

Bottomline : I am still in my long USD/CHF trade. The US Dollar retreated from the sharp spike a few days ago on anticipation that the bailout plan would not reach a consensus, but overall the US dollar is not dead. I think there are a lot of people out there who think that the US dollar would be doom. I continue to believe that commodities are in for a slide, including gold.

In "Can fluctuations in the consumption-wealth ratio help to predict exchange rates?" by Jorge Selaive and Vicente Tuesta, 2006

the authors have found that the consunption wealth ratio to be fairly accurate in predicting the nominal exchange rate.

The difficulty in predicting exchange rates using macro fundamentals has been a challenge in international macroeconomics since the seminal paper by Meese and Rogoff (1983). Mnay found that none of the proposed models were able to outperform a simple random walk.

In their paper Lettau and ledvigson (2001) attribute a key role of fluctuations in the aggregate consumption-wealth ratio for predicting stock returns over short and intermediate horizons. When excess returns are expected to be higher in the future, forward looking investors will react by increasing consumption out of current asset wealth and labour income. According to guo (2003), if Americans invest in foreign currencies, the returns of the portfolios will finally be a function, among other fatcors, of the relative depreciations or appreciations of the foreign currencies. This suggests a role for the consumption-wealth ratio to predict the nominal exchange rate.

The diagram below shows the consumption-wealth ratio as well as the exchange rate of the Canadian dollar.




The diagram shows that there is some relationship on the deviaiton of the consumption-wealth ratio and the future exchange rate.

The author argues that because the consumption-wealth ratio are strong predictors of asset returns, the consumption-wealth ratio may provide an excellent predictor of exchange rates. However, he found that the fluctuations in the consumption-wealth ratio does have a significant impact on FX forecasting and does help to a certain extent on forecasting FX abilities. He proposed further research to be done on how international macro-variables might affect FX rates, especially on bilateral net foreign asset position among countries, as Kilian and Taylor have previously found a significant relationship on the variables.