Markets

The US dollar’s bull market not yet over

The US Dollar Index’s fall from grace from 102.60 in January to 93.50 now was due to myriad political, financial, data driven and positioning factors. One, President Trump has been enable to boost US GDP growth to the 3 per cent level he promised in his campaign. First quarter US GDP growth was a dismal 1.4 per cent even as European growth/PMI have surged. This led to a surge in the euro above 1.17 on all-time highs in German IFO Institute business sentiment from a 1.05 low in January.

Two, the election of President Macro in France and the defeat of the National Front has slashed political risk in Europe while Kremlingate and the Mueller investigations of the Trump clan has raised political risk in Washington. Trump has been unable to offer a credible tax reform or fiscal stimulus plan to a Congress over which has forfeited leadership. If relative political risk shapes currency trends, the euro/dollar was the winner of 2017, up 10 per cent in its first seven months.

Three, Fed chair Janet Yellen turned dovish in her Congressional testimony while ECB President Mario Draghi spoke about the “end of deflation” at the Sintra, Portugal monetary conference and hinted at a taper in his Frankfurt press conference. Predictably, the yield on the 10-year German Bund almost doubled to 0.56 basis points, ballast for the spectacular euro rally in the past two months.

Four, the financial markets were positioned long US dollars for the “Trump reflation trade” after the election. Once Trump failed to kick start his legislative agenda, and got ensnared in Russiagate, Planet Forex dethroned King Dollar. This led to the Euro as the best performing G-10 currency after the Swedish kroner. Global growth data gathered momentum even while US growth data lost momentum.

Five, Morgan Stanley estimates financial/banking deregulation has created an extra $100 billion in excess capital on Wall Street that was exported abroad once Trump did not expand the productive frontiers of the US economy. This meant a softer US dollar.

Six, US Dollar Index began its historic surge in April 2014, when it was 78 and rose almost 30 per cent in the next thirty months. This period also coincided with a historic plunge in crude oil prices and a collapse in many emerging market currencies. The false breakout of the US Dollar Index in January was a powerful bearish, trends reversal signal.

The July FOMC was dovish because it did not reiterate Janet Yellen’s earlier assertion that the fall in core inflation below 2 per cent will be “transitory”. The Federal Reserve expects to shrink its $4.5 trillion balance sheet “relatively soon” (the September FOMC?) but only after it evaluates how the economy evolves.

The US dollar sagged after the July FOMC, primarily against the Japanese yen and the Canadian dollar. I remember being in France in August 2008 when the euro was 1.60 and “le tout Paris” thought “le buck” was merde Little did we know that Lehman Brothers would bite the dust a month later and trigger the end of the 2001-2008 US dollar bear market. For me, the trade of the decade was to short sterling even though cable’s post Thatcher high was 2.11 in November 2007. Sterling’s brutal fall to 1.35 in the next year bigger than the devaluations of 1992 under John Major or 1968 under Harold Wilson. I knew all the talk about the US dollar losing its reserve currency status due to Bush, the Iraq war, $148 Brent crude or the death of Mickey Mouse was nonsense.

Despite the safe haven dollar panic bid after Lehman’s failure, the next US dollar bull market did not begin until April 2014 and the Yellen Fed did not hike rates until December 2015. Is the third post Bretton Wood US dollar bull market now over? No. The US central bank will reduce its balance sheet by at least $180 billion by next summer. This will happen while the ECB balance sheet continues to expand by at least another ?400 billion. The Fed Funds rate will be 1.50 in July 2018. The ECB deposit rate will be minus 40 basis points. Macron’s Reaganomics will trigger strikes in Paris this fall. Italian politics is a time bomb. The euro rally will not last. This is a correction in the US dollar bull market, not its death rattle.

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