Logic suggests the Dollar's too high.... but then again, the value of the greenback isn't always entirely logical

 

ref :- "The U.S. Dollar Is King But It Commands Too High a Premium" , Bloomberg Opinion by Marcus Ashworth

The much-awaited annual symposium of the world's movers and shakers at Jackson Hole takes place on Thursday.... or rather, it doesn't. The renewed march of Covid and its particularly troublesome Delta variant means that the great and the good will not now be headed to Wyoming and the event will instead be a virtual one.

Jackson Hole is important for a number of reasons, but top of the list for those involved in markets is the fact that over the years various Chairs of the Federal Reserve have used the occasion to let slip previously unstated Fed thinking on future monetary policy moves. Many have been of the opinion that Jay Powell would use this year's get-together to reveal plans on when and how the Fed will start tapering its massive bond-purchasing programme. The change to a virtual conference doesn't in theory downgrade the conference in terms of importance or profile but it's legitimate to wonder, as some are, whether it makes the chances of an announcement of such a sensitive policy decision any less likely. Might Mr Powell now wait until September's FOMC meeting ? 

We started with Jackson Hole because of course the Fed's monetary policy is a huge element in determining the value of the US Dollar, which Marcus Ashworth in his Bloomberg Opinion piece argues is too high. The Dollar Index (a trade-weighted measure of the Dollar's value) was trading at 93.50 on Friday. In January it traded as low as 89.42 and after a spike that peaked at the end of March it traded close to that level again as recently as the end of May.

Whenever anyone discusses what might be the "fair" value of the Dollar, they must first acknowledge one obvious, universally-accepted fact. The US currency is the ultimate of safe-havens.... when the world is in trouble (as it surely is now), investors are most comfortable with their money in dollars. It's an indisputable truth, and more often than not it will override other fundamental arguments that point to a different course. It's something that all prospective "shorters" of the Dollar must take into account. Having done so, if one then decides that either the safe-haven factor doesn't apply or that it's gone as far as it will go to boost the value of the Dollar, then.... well, you pay your money and take your choice.

Since the world is still plainly in a bad place, which might in fact be getting worse rather than better, we have to assume that it's the latter of the two scenarios that applies here. The surge in the Delta virus might seem to reinforce the safe-haven argument but not if you believe that it has already run it's course, that the Dollar is already "fully-priced". One could easily make the case that the US economy actually looks more vulnerable to Delta's onslaught than any other in the advanced world, and that it's time to replace anxiety-driven buying of the greenback with searching for alternatives. Moreover, if that anxiety results in a postponement of any Fed tightening of policy, or a reduction in its pace, that would undermine the argument for buying Dollars on the basis of widening interest-rate differentials.

And whilst we're on the subject..... there's a great swathe of investors who do not differentiate between tapering bond-purchases and raising interest rates. However the Fed tinkers with its QE, it is not likely that interest rates will rise before 2023. Doing the former does NOT mean that it will be quickly followed by the latter.

Then there's inflation. Foreign exchange traders always face a dilemma with this subject. Up to this point, the prevailing argument has been that the threat of inflation brings on rate rises, a widening of rate-differentials and therefore a stronger currency.... all perfectly logical. But perhaps because no meaningful inflation threat has been faced for so long, perhaps we've lost sight of the fact that high inflation on any extended basis is in fact very damaging to economies and their currencies. Quoting Kit Juckes of Soc. Gen., Mr Ashworth points out that inflation is marching much more strongly in the US than it is elsewhere. How Dollar-bearish that is depends on which side of the dilemma you settle on, and whether above-desired levels of inflation do indeed prove to be "transitory". Whilst the prospect of rate rises in the US is dollar supportive, it wouldn't be for long if the Fed can't get the inflation genie back in the bottle.

There are others things that Mr Ashworth argues do not seem to equate with the value of the dollar: 

1. Dollar shortage?.... When the dollar spiked at the start of the pandemic, it was a classic supply and demand scenario. People wanted to be in dollars (for safe-haven purposes) and there weren't enough around. Result ? A higher price, naturally. That situation definitively no longer applies. QE has swollen the Fed's balance sheet to over $8 trillion.....  "That's a lot of dollars in the system". Add in huge currency swaps with other central banks and ongoing QE (tapered or not), and no one could now say that there's any shortage of Dollars.

2. Commodities.... After a surge the price of industrial commodities (oil, copper, iron ore)  --  the best measure of global growth  --  have all turned sharply lower. This does not fit with the usual pattern of strong dollar cycles, and may be telling us something.

3. US yields.... US 10yr Treasuries yield around 1.25%, down about 50 basis points since early April and narrowing the yield premium over other global bond markets. Not, one would think, conducive to a strong Dollar.

We wouldn't argue with any of Mr Ashworth's points, which add up to a cogent argument for shorting the dollar. But it would take a bit nerve do so aggressively against a background of continuing global stress and a fog of talk about rising rates, misguided or not, And in truth, we're always a little wary of taking a strong view "merely" because the current price doesn't seem to make much sense  --  markets often don't, and as we saying the other day, the market is always right. But of course if you stuck too rigidly to that mantra then you might never make a decision at all.... Mr Ashworth has made his, and good luck to him.