A Currency For All Seasons

John Leiper – Chief Investment Officer – 9th August

Having identified, and benefited from, the 7% fall in the value of the US dollar index since late April, we have now turned tactically cautious.

Since breaking through its 10 year support line, in white, the index has twice tested support at 92.5 and now formed a ‘doji’ candlestick pattern for the week. This pattern is comprised of a small body and long wicks and typically signifies indecision between bulls and bears. It is usually found at the bottom of trends and can be associated with a possible reversal of direction.

On mobile: review detail in landscape mode

This is consistent with the latest reading from the relative strength index which puts the US dollar index into oversold territory.

Prior instances, identified by the yellow arrows, are consistent with a subsequent rebound in the value of the US dollar, typically lasting several months and usually within the existing longer term trend, be it lower (such as the downtrend of the 2000s) or higher (throughout the subsequent decade).  

On mobile: review detail in landscape mode

Setting aside the technicals, one fundamental reason why the US dollar could recover from here, is liquidity.

As detailed in Don’t Fight The Fed (26th May 2020), throughout March and April, the Fed massively outpaced the Treasury, by buying more bonds than the Treasury issued, ensuring liquidity was plentiful.

However, over the last two months, in a reversal of roles, the US Treasury has out-issued the Fed, resulting in a reduction in US dollar liquidity in the commercial banking system. This is demonstrated in the chart below by the fall in the blue line on the far right hand side. The US dollar is highly correlated to this measure of liquidity, which may lead to a stronger currency over the coming months (right hand axis is inverted).

On mobile: review detail in landscape mode

The main reason for the drain in liquidity is the accumulation of cash held in the Treasury General Account (TGA) which has now reached 1.8 trillion dollars.

Treasury Secretary Steve Mnuchin undoubtedly plans to deploy these funds and is working on the assumption that the cash balance will fall to $800 billion by the end of Q3. However, that was also the plan for the end of Q2. Meanwhile, congressional leaders remain far from a coronavirus relief deal and President Trump’s executive action, announced over the weekend, will likely prove ineffectual. Should TGA cash levels remain elevated over the near term, this could bolster the dollar as described above.

On mobile: review detail in landscape mode

 

A stronger US dollar would not necessarily run contrary to Donald Trump’s political ambitions as evidenced by the close correlation between the currency and probability of electoral success as forecast by PredictIt.

On mobile: review detail in landscape mode

Then there are seasonal factors to consider. The US dollar is heading into a seasonally strong period with average gains, over the last ten years, of 0.3% in August, 0.2% in September and October and 1.7% in November.

This seasonality coincides with the presidential cycle. Over the last 30 years, during which time there have been seven presidential elections, the US dollar has rallied approximately 3% in the 50 day run-up to election day.

On mobile: review detail in landscape mode

Whilst the likelihood of a technical bounce in the value of the US dollar is high, we remain strategically bearish over the medium term. Key drivers include the surge in the money supply, high debt levels and expectations for further easing resulting in lower for longer nominal interest rates and rising inflation expectations. Low fx hedging costs will also weigh on the currency over time as hedge ratios rise globally.

Turning to the UK pound, the catalyst for the move higher in GBP/USD at the end of July was Michelle Barnier’s comments, in a closed door meeting, that a trade deal with the UK was likely. We believe fears of a no-deal scenario are overplayed and retain our medium term forecast for 1.40 to 1.45 versus the US dollar. However, this remains the big outstanding hurdle and an ongoing source of volatility over the coming months.

On a near-term basis the concern is that the aforementioned rebound in the US dollar could translate into GBP weakness. One positive development came on Thursday from the Bank of England’s MPC minutes which forecast that that the economic slump would be less severe than previously expected whilst downplaying the role of negative interest rates. This will likely prove short-term supportive and it was reassuring to see GBP/USD initially rise towards 1.32.

Over the last few days we have seen two attempts to break higher and three attempts to move lower, all of which have failed. Next week could prove eventful with second quarter GDP data alongside industrial production and a labour market report all of which have the potential to move the needle.

 

On mobile: review detail in landscape mode

This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Bloomberg, Tavistock Wealth Limited unless otherwise stated.  

Want to know more about the Equity Markets?

Please contact us here:

11 + 2 =

Recent blogs
Technical Perspectives

Technical Perspectives

In last week’s blog we discussed the ‘Nasdaq whale’, Softbank, and the role it played, alongside an army of retail investors, driving tech prices ever higher prior to the recent correction. These short-term ‘technical’ flows are driven by the options market as traders look to hedge their underlying exposure, amplifying moves both lower and higher.

read more
A Speech For The History Books

A Speech For The History Books

In a speech for the history books, last week Fed chairman Jerome Powell announced a significant change to the way it conducts monetary policy by formally announcing ‘average inflation targeting’.

read more
Room to Run

Room to Run

Despite the fact the coronavirus has plunged many countries into recession, global equity markets are now back at all-time highs, as measured by the Bloomberg World Exchange Market Capitalisation index.

read more
Rising Phoenix

Rising Phoenix

In The Return Of Inflation (5th June 2020) we made the case for a transition from the existing deflationary narrative to one in which markets start to price-in inflation.

read more
All That Glitters…

All That Glitters…

The US dollar index, which represents the value of the dollar against a basket of developed market peers, fell through key technical support to its lowest level in 2 years.

read more
Q3 2020 Quarterly Perspectives

Q3 2020 Quarterly Perspectives

Despite suffering the worst pandemic in over a century, and the sharpest economic contraction since the second world war, global equity and bond markets staged one of the fastest recoveries of all time in Q2.

read more
The Return of Inflation

The Return of Inflation

Quantitative easing, or QE, is where a central bank creates money to buy bonds. The goal is to keep interest rates low and to stimulate the economy during periods of economic stress.

read more
The Powell Pivot 2.0

The Powell Pivot 2.0

In January 2019 Jerome Powell pivoted from a policy of interest rate increases and balance sheet cuts to interest rate cuts and, later that year, balance sheet expansion.

read more
Don’t Fight The Fed

Don’t Fight The Fed

Over the last decade, the Fed has increasingly resorted to unconventional monetary policy, such as quantitative easing, or QE, to stimulate the economy.

read more
Super Contango

Super Contango

In an unprecedented day in the history of oil trading the price of the front month contract for West Texas Intermediate (WTI) oil fell below zero to -$37.63.

read more
The beginning of the end?

The beginning of the end?

The coronavirus has brought economic activity to a virtual stand-still and transformed a strong global economy, with lots of debt, to a weak economy… with lots of debt.

read more
Halcyon Days

Halcyon Days

Today, global equity markets have fallen again and yields on developed market government bonds have collapsed even further. In my opinion, there are two diametrically opposed events playing out at the same time.

read more
A Time to Remain Calm

A Time to Remain Calm

This is a time to remain calm, patient and focused on fundamentals whilst relying on sound risk management practices. Over the last week the number of confirmed cases of COVID-19 has risen to more than 83,000 people across 50 countries.

read more
ESG in the Spotlight

ESG in the Spotlight

Environmental, social and governance (ESG), a byword for sustainability, has in recent weeks occupied rarefied real estate on the landing page of several finance industry titans.

read more
UK Growth

UK Growth

The long-term growth prospects for the UK economy remain positive and the uncertainties surrounding the Brexit negotiations will fade with the passage of time…

read more
Rational Exuberance – US Equities

Rational Exuberance – US Equities

Since its low on the 9th of March 2009, the S&P 500 has gained over 277%, the second longest and third largest gain on record. Understandably, many investors are concerned about the size and scale of the current bull market.

read more
UK Elections

UK Elections

Theresa May finally relented to the mounting pressure from within the Conservative Party and announced that a general election will be held on the 8th of June 2017.

read more