The U.S. dollar continues going up to major global currencies amid the rise in Treasury yield, lower risks of easing the Fed’s monetary policy in 2019 to 7% from 21% and Loretta Mester’s dovish comments. Cleveland Fed president announced that if the U.S. economy expands according to her forecast of 2%-2.5%, the central bank is likely to go on monetary normalization. However, despite the greenback’s short-term rise, its middle and long-term outlook is more pessimistic.
According to Morgan Stanley (NYSE:MS), the USD has reached its ceiling. In addition to such factors as a decline the U.S. economic expansion and a pause in the Fed monetary restriction, the dollar will be pressed down by the capital outflow from the U.S. securities market. The hedging cost of the U.S. securities is the highest: with its use, the performance of the investment in 10-year Treasuries for European investors is negative (-0.35%). It is one thing when foreigners are confident in the greenback’s strength, they may not hedge against the risks. Another matter when the U.S. dollar outlook is bearish. Foreigners will withdraw their capitals; and, since their investments in the U.S. securities are much larger than the Americans’ investments in foreign stocks and bonds, the USD will be challenged. Based on the above, Morgan Stanley forecasts the EUR/USD growth up to 1.3 and the USD/JPY drop as deep as at 102 in 2019.
Obviously, the capitals flows are of key importance for any currency; however, investors’ opinions are first of all influenced by central banks. With this regard, the informal meeting of Jerome Powell and Donald Trump, as well as a number of researches of low efficiency of negative interest rates give some clues. I stressed the Fed’s commitment to the modern theory of secular stagnation. It explains that the interest rate that seems to be low is, in fact, high. According to the analysis of Princeton University and Chicago's School of Business, monetary easing displaces small firms from the market, they lose out in competition with large companies. As a result, productivity declines and the economy slows down.
Dynamics of productivity growth and Treasury yield
Source: Wall Street Journal.
According to the research San Francisco Federal Reserve Bank research, if the Fed switched to the negative interest rate in the past, the inflation could have reached its 2% target already in 2011, and it would have been easier to normalize monetary policy. Such an approach suggests that the central bank already has the room for maneuver to manage a future recession, that is, it makes no sense to hike the rate.
The only fact that Donald Trump, constantly criticizing the Fed, has met the FOMC CEO, suggests that the recent change in the central bank’s opinions was not by chance. Both sides are interested in the USD weakening; so, the EUR/USD consolidation in the range of 1.1265-1.1485 looks like the calm before the storm.