After shredding the weak sauce of Krugman-worshiping journos in a recent rant, it’s only fair to give some credit: Tom Stevenson of the UK Telegraph puts together a solid macro case for a bottoming US dollar.
The piece, “After a decade of decline, it’s time for the dollar to have its day,” is worth perusing.
Here’s our version of the cliff’s notes:
The dollar fell against a broad basket of currencies for a decade due to:
- expensive military adventures abroad
- aggressive tax cuts at home
- broad fiscal deterioration
- commodities surging as an asset class
- emerging markets drawing investment dollars
Ten years earlier (in the 90s) the $USD situation looked different:
- tax rises + peace dividend from fall of Berlin Wall
- fiscal deficit shrinking / turning to surplus
- positive real interest rates
- global fervor for US equities as an investment destination
Now the picture is reverting to more of the “nineties” than the “noughties:”
- progress on budget and trade deficits
- military withdrawals from Iraq and Afghanistan
- commodities as an asset class cooling
- emerging markets as an asset class cooling
- US recovery strongest in the developed world
And as bonus effects:
- knock-on effects of the US energy boom (natural gas / shale)
– Japan aggressively devaluing its currency in attempts to reflate
– Europe on verge of recession / depression, forced to emulate Japan?
And as catalysts:
- Federal Reserve telegraphing hints of ultimate withdrawal
- US recovery putting 6.5% unemployment recovery target in sight
- US equity / real estate strength drawing foreign investment dollars
Oh and then there’s this: Even as the Fed’s mouthpiece (WSJ reporter Jon Hilsenrath) leaks whispers of tightening, central banks around the world are getting their cut on:
Joining a recent wave of global central bank easing, the Bank of Israel cut its benchmark interest rate Monday in a surprising move aimed at relieving upward pressure on the country’s currency.
A growing number of central banks have been cutting rates. Slowing inflation gives them more leeway to pursue policies aimed at stimulating growth amid a global economic slowdown. Meanwhile, some central banks, including Israel’s, are trying to prevent their currencies from rising and hurting exports.
Central banks in Australia, South Korea, Poland, India and Hungary have pushed their benchmark borrowing rates lower in the past few weeks.
- WSJ, Banks Rush to Ease Supply of Money
As far as central bankers go, mini-doves are breaking out everywhere, even as the once-biggest dove of all (the US Fed) starts morphing into a hawk. How ’bout them apples?
As Larry David might say, “Pretty good. Prettay, prettay good.”
And how about the price action? That’s pretty good too.
Take a look (via UUP): 
Point of amusement: There is a certain class of macro perma-bear for whom the thought of a stronger dollar is impossible… like one of those wacky staircases in an M.C. Escher painting.
This comes from factors like a one-sided focus on the liability side of the U.S. balance sheet (ignoring the asset side)… an inability to see currencies in relative terms (as the USD does not trade in a vacuum, it trades against other currencies)… a Calvinist need to see the sins of debt repaid, and so on.
And for a possibility that could really bake your noodle, consider this: The dollar is likely to strengthen more against a weak recovery than a strong one.
Why? Because of bonds (US treasuries):
- If the economy strengthens too fast, treasuries get dumped.
- If treasuries get dumped, the Federal Reserve has to act as buyer of last resort.
- Failing this, plummeting bond prices lead to spiking interest rates…
- Which in turn kill the recovery.
- The Fed cannot allow the recovery to be killed.
- So in this instance, it prints dollars with which to buy bonds…
- And sacrifices the dollar for the sake of safeguarding the strong recovery.
:
- If the recovery remains weak, treasuries are never really jeopardized.
- With an anemic recovery, there is no “real fight / true exit test” (as referred to in this rant).
- A sluggish, half-dead recovery is one in which treasuries remain a safe haven…
- And long-term rates stay low as a function of chronic and persistent weakness.
- In this scenario, the Federal Reserve can edge towards less accommodation…
- Even as Japan and Europe increasetheir levels of accommodation…
- And the US wins the “least pathetic recovery” race in relative terms.
And so, irony of ironies, to say “The dollar can’t get stronger because the US recovery is bogus” is an exactly backwards argument.
It is possible for the dollar to get stronger bit by bit, via incremental progress, precisely because the US recovery is bogus (or rather, too weak and anemic to really move the needle on a treasuries exit).
What the dollar bears REALLY need is the threat of a full-on bond market crash, which doesn’t really materialize until / unless the US recovery starts looking so good and so solid there is no question we are out of the woods, forcing the “bond panic + Fed save at expense of USD” scenario — but how does a genuinely strong recovery square up with traditional bearish viewpoints again?
Meanwhile take a look around at what’s happening beyond US borders:
- Canada’s housing market is looking shaky (ready for a bubble burst)?
- Australia’s housing bubble burst is just a matter of time
- China is still slowing and stumbling and fumbling
- (60% of Chinese multi-millionaires want to leave for pete’s sake!)
- Japan is voluntarily turning its currency into confetti
- Europe is staring recession / depression in the face
- All this plays into the “least ugly in a beauty contest” dynamic…
Easy takeaway: Start looking for ways to benefit from a slow-but-steady strengthening dollar trend — like shorting the commodity currencies, Aussie Aussie Oi Oi! — and be wary of asset classes and equity plays for which a weakening USD served as a long-standing tailwind. (And if you want to know what we are doing in light of all this, scope out the Mercenary Live Feed.)
Disclosure: This content is general info only, not to be taken as investment advice. Click here for disclaimer