Not everyone thinks that a weakening US dollar will cause a sell-off in bonds and rising interest rates. In last week's edition of The Edge Singapore, Kevin Colglazier, Head of Global Fixed Interest at First State Investments, gave his views in an interview with the magazine:
On the US dollar:
When you see these sort of press articles [about American profligacy and the possibility of an imminent collapse in the US dollar], the end of the sell-off is probably near because it is reaching the last person in the trade. In 2005, you may well see further dollar weakness because the US current account will continue to be poor. But I think the majority of the dollar sell-off is over.
On the rise in the federal funds rate:
Last year, the Fed hiked rates 125 basis points and yet the bond market...traded sideways... You can't say that the Fed is raising rates so the bond market must sell off. It is a function of where we are in the economic cycle and what the bond market thinks of that. At some points in the cycle, the bond market might take comfort from the Fed raising rates because it is cooling the economy.
On the US budget and economy:
I think one of the surprises in 2005-06 is that Bush will turn out to be more fiscally prudent than the markets are giving him credit for. We are not going to see a recession or anything, but I don't see how growth won't be less than last year.
On low inflation:
[Developed countries] have effectively outsourced so much manufacturing that is commodity oriented, and the amount of oil required to produce one unit of GDP [in developed countries] has fallen dramatically since 1973. And, producers in Asia and China have so many other advantages in their favour that the increase in commodity prices can be partially mitigated. Globalisation and the Internet are just fantastically deflationary. This is the most deflationary event since the 1880s when you had a combination of railroads, refrigeration and the opening of the prairies in the US, Canada, Australia and Argentina, which really depressed food prices. This is a pretty big deflationary story. It is not going to go away any time soon.
The bottom line:
If you could do a trade, close your eyes and wake up at the end of December, you would probably want to have a small long position in the bond market.
While I have personally been arguing for a rise in interest rates, the views expressed by Colglazier are also highly plausible. Things are seldom clear-cut in investment.