This Time It’s Different

John Leiper – Chief Investment Officer – 24th July 2020

There are growing signs that the US dollar may finally roll over.

The chart below shows the US dollar index, in white, and two associated lines in blue and purple, known as Bollinger bands. Bollinger Bands are a technical indicator used in financial analysis. They represent the price and associated volatility of an index, in this case defined as 2 standard deviations above and below the moving average price. During periods of low volatility, the bands narrow and the width between the lines gets smaller. During periods of heightened volatility, the lines diverge and the width between the Bollinger bands gets wider.

Over the last two decades there have been just three occasions where Bollinger band width has broken out of its prior narrowing trend. The first two times this happened, during the subprime mortgage crisis and eurozone growth slowdown, the US dollar appreciated noticeably. We are currently in the midst of a third breakout, only this time the US dollar seems to be weakening.

 

On mobile: review detail in landscape mode

I first raised the possibility of a weaker US dollar in One Currency To Rule Them All… (And In A Crisis Bind Them) dated 20th April. Since then the US Dollar index has fallen -5%.

There are many reasons to believe the greenback is more likely to depreciate than appreciate over the coming months. Chief among them is the euro. The EU’s relative success in tackling the coronavirus and recently agreed stimulus package points to renewed optimism in the region. Whilst a dysfunctional eurozone has long proved bearish for the common currency, recent progress means the euro is once again a credible alternative to the US dollar.

The stark contrast in policy response to the virus between China and the US is also dollar bearish. Whilst the Fed is likely to continue to ease monetary policy, the People’s Bank of China is moving in the other direction. Tighter relative monetary policy has resulted in record yield differentials which will likely push the yuan higher against the dollar going forward.

On mobile: review detail in landscape mode

Fundamentally, the US twin deficit, which refers to both a trade and budget deficit, has now reached 17% of GDP (right hand axis inverted). This is a large number and typically not good news. Once economic growth recovers, and central banks taper asset purchase programs this underlying deterioration points to dollar weakness.

On mobile: review detail in landscape mode

Further, the cost of hedging USD assets has fallen notably over the last year. As a result, investors buying USD assets are more likely to hedge the currency than might have been the case previously, thereby weighing on the currency.

On mobile: review detail in landscape mode

Finally, US companies have dramatically slowed the pace at which they are repatriating offshore profits to the US. Following tax cuts in 2017, companies brought back approximately $850 billion in 2018 but this fell to under $400 billion in 2019 with the trend look set to continue into 2020.

On mobile: review detail in landscape mode

US dollar weakness is also consistent with the growing probability that Trump does not win the next election as currently implied by PredictIt. However, it is still far too early to call the election one way or the other and as Harold Wilson once said, “a week is a long time in politics” (in my humble opinion a week is even longer in markets).

On mobile: review detail in landscape mode

As such, it would be unwise to give up on the dollar entirely. Time and time again the US has reasserted itself on the global stage. Should the medium-term economic outlook deteriorate markedly or geopolitical tensions rise then we could see safe-haven flows back into the dollar.   

Indeed, that is what happened back in March. During the early stages of the corona crisis the US dollar weakened to current levels (dotted white line) just prior to the subsequent, and significant, dollar rally. Back then, investors were desperate for liquidity and the dash-for-cash into USD, against a global shortage of dollars, sent the currency rocketing. Since then, however, the Fed has dramatically increased the money supply, with M2 (which is a broad measure of money including cash, checking/savings deposits and money market funds) up 25% year-on-year.  The Fed also increased the global supply of dollars via fx swap lines to foreign central banks.

In this new, liquid world, there may well be cause to believe “this time it’s different”.

 

On mobile: review detail in landscape mode

Despite recent weakness, the US dollar remains its long-term uptrend. Where the dollar goes next is key and the direction of travel will have implications for the global economy and our investment strategy. Should the dollar move lower, through long term support, then we are likely to see a rotation into pro cyclical risk assets, whereas a bounce higher is more consistent with a renewed bout of risk aversion later this summer.

Whilst we retain a cautious bias, we are positioned for a weaker US dollar via our commodity carve-out and overweight allocation to emerging markets.

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:

15 + 5 =

Recent blogs
Further For Longer

Further For Longer

On Tuesday Fed Chairman, Jerome Powell, made a speech at the National Association for Business Economics, during which he implied the government should err on the side of caution and provide too much stimulus rather than too little. 

read more
Smart Beta Unwrapped

Smart Beta Unwrapped

Our Chief Investment Officer, John Leiper, was recently invited to provide his valuable insights as part of ETF Stream’s video conference livestream: “Beyond Beta Europe Digital: Smart beta unwrapped”.

read more
Life Imitating Art

Life Imitating Art

Saturday Night Live has a reputation for expertly parodying presidential election debates. My all-time favourite is Al Gore (Darrell Hammond) versus George Bush (Will Ferrell) and this year didn’t disappoint with expert performances from Donald Trump (Alec Baldwin) and Joe Biden (Jim Carrey).

read more
Emerging Markets: ETF Stream

Emerging Markets: ETF Stream

Our Chief Investment Officer, John Leiper, was recently invited to provide his valuable insights into emerging markets as part of ETF Stream’s video conference livestream: “Big Call: Emerging Markets”.

read more
The Call-Up

The Call-Up

Last week the FTSE Russell decided to include Chinese government bonds in its flagship World Government Bond Index (WGBI). The decision follows similar moves, from JP Morgan and Bloomberg, and a failed attempt to do so just one year prior which resulted in a number of reforms, to increase accessibility and currency trading options, that ultimately paved the way for benchmark admission.

read more
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