Down Goes The Greenback?

Roger Blitz and Eric Platt of the Financial Times report, US dollar close to erasing Trumpflation gains:
The dollar index, a barometer of investors’ reflation expectations for the US economy, fell on Monday to trade at its lowest level since the presidential election, signalling that the so-called Trump trade is nearing the point of being fully unwound.

Measuring the reserve currency’s performance against a basket of its peers, the dollar index fell 0.7 per cent to 98.90, a level last seen on November 11. As the dollar waned, global equities were also under pressure while havens such as the yen, gold and government bonds attracted buyers.

In opening trading on Wall Street, the S&P 500 fell 0.9 per cent, as the KBW index of US banks dropped more than 2 per cent. Bank shares have fallen more than 10 per cent since they peaked earlier this month. Goldman Sachs and Bank of America, two of the biggest benefactors of the “Trump trade” that buoyed markets in the wake of the election, both slumped 2.5 per cent on opening, and Morgan Stanley fell 4.2 per cent.

Rodrigo Catril, forex analyst for National Australia Bank, said: “The Trump-specific boost to the US dollar and commodity prices . . . is at risk of completely unwinding.”

The dollar has come under increasing pressure since it peaked at the start of the year, and last week’s collapse of the president’s healthcare bill intensified selling of the currency on Monday.

The weakness in the currency reflects doubt over the Trump administration’s fiscal plans to boost the economy and whether the Federal Reserve will tighten policy at a faster pace in the coming year. Lower bond yields on Monday also contributed to the weaker tone for the dollar as markets reflected a sense that the Trump administration faces a challenge passing tax reform and fiscal stimulus measures through Congress (click on image).

Simon Derrick, chief market strategist at BNY Mellon, said: “Failure to pass the healthcare bill will probably prompt investors to question whether tax reform will prove any easier”. He added higher bond yields were one of the key drivers of the dollar’s post-election rise.

“As such, it is perfectly possible that the week will see yields moderate further and the dollar resume its push lower,” he said.

The dollar was particularly weak against the yen and the pound, down 1.1 per cent in both cases, and 1 per cent lower against the euro.

Emerging market currencies also benefited from the dollar sell-off, although weak commodity prices kept some parts of EM forex in check. The South Korean won was up 0.8 per cent, while the Taiwanese dollar rose 0.7 per cent.

The Swiss franc, a traditional haven when the market is risk-averse, rose 0.6 per cent, while gold was up 1.1 per cent and Asian and European equities retreated.

Markets including the dollar index had briefly risen late on Friday in the hope that the White House could begin to focus on tax reform, a key element of the Trump trade.

But Sue Trinh, Asian forex strategist at RBC Capital Markets, said this optimism “gave way to the realisation very big tax cuts were highly dependent on the savings from replacing Obamacare”.

That could raise concern among fiscally prudent conservatives, said MUFG’s Lee Hardman. “In these circumstances, the US dollar is likely to remain offered for now with no obvious trigger to reverse current negative sentiment in the week ahead,” he said.
Dion Rabouin of Reuters also reports, Dollar skids to four-month low as Trump trade deflates:
The dollar fell to its lowest since November against a basket of currencies on Monday as investors lost confidence in prospects for a U.S. fiscal spending boost under President Donald Trump after his failure to pass a major healthcare reform bill.

Trump's inability to deliver on his campaign pledge to overhaul the nation's healthcare system marked a big setback for a Republican president whose own party controls Congress, and raised doubts over whether he will be able to see through tax reforms and a proposed spike in spending.

The dollar was down 0.65 percent on the day against the basket of major currencies used to measure its broader strength. It fell as low as 98.858, the lowest since Nov. 11.

"The assumption was that if you can’t get healthcare done that some of the other things on his agenda, mainly the tax reform, would be a harder sell," said John Doyle, director of markets at Tempus Inc in Washington.

The reduced expectations for Trump's reflationary tax and spending proposals also sent equities lower, with the U.S. S&P 500 down 0.75 percent.

The dollar index had risen to a 14-year high near 104.00 in early January when expectations for inflation-boosting stimulus under the Trump presidency were at their peak, with investors betting big on the so-called "Trumpflation" trade.

Speculators increased bullish bets on the U.S. dollar in the week up to last Tuesday for the third time on the trot, pushing net longs to their highest since Jan. 31, Commodity Futures Trading Commission (CFTC) data showed on Friday.

Against the yen, the dollar fell more than one percent to 110.09, its weakest since Nov. 18. The dollar hit its lowest against the Swiss franc, another traditional safe haven for capital, since Nov. 9.

The euro reached $1.0904, its highest since Nov. 11. Sterling, the worst performer among the G10 group of major currencies against the dollar this year, hit an 8-week high of $1.2615.

"The British pound is still close to its weakest level in 30 years, so it has some upside especially since data out of the U.K. has been better," Doyle said. "The Japanese yen has had a great run because stocks around the globe are down. So if you start breaking it down into each individual currency there’s a good reason, but overall it’s just a dollar negative day."
Indeed, it's just a dollar negative day mostly owing to the fallout from failing to pass the healthcare bill on Friday.

What typically happens after some political bombshell in Washington is the US dollar declines, the yen gains, US stocks and other risk assets (like corporate bonds, emerging market stocks, bonds and curencies, etc.) get slammed and US Treasuries rally.

Add to this positioning of major speculators, all long risk assets and the US dollar, and it's hardly any wonder to see this negative reaction.

But it's too early to make any big calls just yet. Yes, President Trump and Speaker Paul Ryan had a major setback on Friday, no doubt about it. They underestimated the deep divide within their own party when it comes to repealing and replacing the Affordable Care Act (aka Obamacare).

Also, US politics is very messy ("it's a sausage factory"), overhauling any major bill especially healthcare is far from easy and requires major compromise from all parties involved in Congress and the Senate.

Does not passing healthcare reform jeopardize Trump's ambitious agenda to cut taxes and increase spending on infrastructure? It most certainly can and Republicans face major hurdles within their own party.

And then there is the debt limit which might throw a monkey wrench into the mix, but for now most think another debt ceiling crisis will be averted.

The last time I wrote a comment on the US dollar was in mid December where I warned of the potential of a crisis developing this year and wrote the following:
As you can see, the US dollar has been on a tear since early August when I told my readers to ignore Morgan Stanley's call that the greenback is set to tumble (my best call of the year and their worst one ever). It is basically hitting a multi-year high.

So what does the US dollar rally mean and why should you care? Well, the US dollar has rallied mostly versus the euro (close to parity which is another call I made back in March) and the yen.

The decline in the yen and euro is actually good for Euroland and Japan because it means European and Japanese exporters will benefit from the devaluation in their respective currency. This is why Japanese and European stock markets have rallied sharply. It's also good news for fighting deflation in these regions because a decline in their currency increases import prices there, raising inflation expectations in these regions.

Unfortunately, raising inflation expectations via a declining currency is not the good type of inflation. It's a temporary reprieve to a long-term structural problem. The good type of inflation comes from rising wages when the labor force is expanding because that increases aggregate demand and shows a strong, vibrant economy.

Now, what does the rising US dollar mean for the United States? It's the opposite effect, meaning it will hurt US exporters and lower inflation expectations in the US. In effect, the US is taking on the rest of the world's deflation demons trying to stave off a global deflationary calamity.

Will it work? That is the multi-trillion dollar question which is why I began talking about global deflation and currencies because as Bridgewater's Bob Prince noted in his presentation in Montreal, with interest rates at historic lows and central banks pushing on a string, currency volatility will pick up. I would add this is where the epic battle versus global deflation will take place.

But again, currency devaluation is only a temporary reprieve to a long-term structural problem fueling global deflation. The six structural factors that I keep referring to are:

  1. High structural unemployment in the developed world (too many people are chronically unemployed and we risk seeing a lost generation if trend continues)
  2. Rising and unsustainable inequality (negatively impacts aggregate demand)
  3. Aging demographics, especially in Europe and Japan (older people get, the less they spend, especially if they succumb to pension poverty)
  4. The global pension crisis (shift from DB to DC pensions leads to more pension poverty and exacerbates rising inequality which is deflationary)
  5. High and unsustainable debt (governments with high debt are constrained by how much they can borrow and spend)
  6. Massive technological disruptions (Amazon, Priceline, and robots taking over everything!)
These six structural factors are why I'm convinced that global deflation is gaining steam and why we have yet to see the secular lows in global and US bond yields.

But now we have a newly elected US president who has promised a lot of things, including spending one trillion in infrastructure and cutting personal and corporate tax rates.

What will this fiscal thrust do? Hopefully it will help create more jobs and fight some of the chronic problems plaguing the US labor market. But if you really think about it, this too is a temporary boost to economic activity because once it's all said and done, those infrastructure jobs will disappear and US debt will explode up, which effectively means higher debt servicing costs (especially if interest rates keep rising), and less money to stimulate the economy via fiscal policy down the road.

This is why some people think Donald Trump's new Treasury secretary, Steven Mnuchin, is just kicking the can down the road if he goes ahead and issues Treasurys with longer maturities in an effort to cushion the US economy from rising interest rates.
Now, fast forward to March. The Federal Reserve recently came out with a somewhat dovish statement as it raised interest rates, sending the US dollar lower.

And with US leading economic indicators reaching their highest level in a decade, the big worry going forward is the US economy will start slowing, especially if the Republicans don't deliver on tax cuts and infrastructure spending (both of these are priced into the market).

What happens if the US economy starts slowing? Well, that's not good news for the rest of the world because the US economy leads the rest of the world by roughly six months. So, once the US economy starts slowing, initially you might see the US dollar decline relative to other major currencies, but this trend won't continue for long.

The biggest threat is that Federal Reserve continues to tighten as leading indicators start to roll over. The Fed might do this because a) it will base its decision on coincident or lagging indicators (like employment and inflation) or b) it just needs more ammunition to confront the next crisis so it can lower rates in case something bad happens.

But raising rates will only propel the US dollar higher and intensify global deflationary headwinds, which will only make the next crisis that much harder to deal with.

In an zero interest rate world, this constant battle between global deflation and inflation is increasingly playing itself out in the currency arena. Either the US dollar will resume its uptrend, importing global deflation to the US, or the yen and euro will rise, reinforcing deflation in these regions.

All I know is we are at an important inflection point where I see US and global leading indicators rolling over in the near term and this will crush risk assets all over the world.

And if a full blown crisis develops, in such a Risk Off environment, everybody will be seeking refuge in US Treasuries and the US dollar.

There is too much exuberance priced into this Risk On market and there were too many US dollar long positions out there going into the year, which is why the greenback was set to tumble.

But if you look at the weekly chart of the US dollar ETF (UUP), you'll see despite the recent selloff, the greenback is still up since July 2015 and it will be interesting to see if it dips below its 50-week moving average and moves back up or bounces off it (click on image):

Will we see the US dollar crisis I warned of late last year? It certainly doesn't look like it right now but that depends on the Fed not making any policy errors and no negative surprises from the rest of the world.

As I end this comment midday Monday, US stocks have snapped back (led by the Nasdaq and biotech stocks), and are trading off their session lows as investors evaluate the possibility of significant tax reform coming from the White House.

The US dollar index (DXY) also snapped back after getting pummeled earlier today as global investors snap up risk assets (click on image).

We shall see if this trend continues, there are so many moving parts to the US economy and financial markets but politics remain very divisive and murky.

All I can tell you is despite the recent selloff, the big multi-billion dollar commodity trading advisors (CTAs) are definitely still long the US dollar, the global macros are probably short, but I wouldn't be surprised to see uptrend resume in the short run even if leading economic indicators start rolling over.

Below, Vasileios Gkionakis, head of global FX strategy at UniCredit, discusses the market reaction to US President Donald Trump's failed health-care bill.

And Patrick Bennett, forex strategist at CIBC, says the dollar has retraced most of the gains after last November and the market is losing confidence on the Trump Administration.

Lastly, bond king Jeff Gundlach was on CNBC recently stating it's just not true that Fed hikes are supportive of financials and the US dollar. Gundlach brings up a good point that too many dollar bulls were positioned long going into 2017.

He's also right, in a rising rate environment, when the yield curve flattens, financials underperform. However, he neglects to mention in a Risk Off environment when there is real fear, bond yields across the world decline and it's spreads that matter most for currencies. Typically in this Risk Off environment, everyone seeks refuge in King Dollar, especially if things get really bad (think back to what happened during the 2008 crisis).

Given my long-term deflation fears, I find it hard to go long the yen and euro relative the US dollar but I also understand that short-term cyclical swings are determined by interest rate policy and positioning data.

Still, I'm not certain we have averted the US dollar crisis I warned of late last year and I'd ignore any calls on the "death of the greenback". That's just rubbish.

A lot of things can happen this year which will send the US dollar higher from these levels, so I'd stay long the greenback and be very careful interpreting too much into the recent political uncertainty or dovish Fed comments which sent the dollar tumbling recently.

The recent selloff was mostly due to positioning and a crowded trade as too many dollar bulls got caught up in Trump euphoria. As I stated above, leading US and global economic indicators are at their peak and rolling over here. If another crisis develops later this year and we go from a Risk On to a Risk Off environment, global investors will seek refuge in US Treasuries and the US dollar.

Bottom line: Don't be too quick to read too much into the recent dollar selloff,  the greenback could come roaring back and this will lead to all sorts of problems in emerging markets and global markets.