Below is a round-up of Longview related views/research & trade ideas – the intention is to publish this most Fridays, updating key themes and highlighting key pieces of (often contrarian) research. Feedback, as always, is appreciated. Equally just ‘unsubscribe’ at the bottom if you don’t want to receive the email.
Whither the Dollar?
Currency volatility is back close to record low levels (FIG 1). With that there is much confusion amongst market participants about the outlook for the trade weighted dollar. Indeed, despite an aggressive and rapid volte face by the Federal Reserve regarding its interest rate policy, and with the market shifting from pricing rate hikes to rate cuts, the dollar has held its own in recent months. Equally, despite a dramatic SELL-off in Q4 last year, an event which typically results in a strong dollar (i.e. driven by risk aversion), the currency is at the same levels that it was at in August last year (just ahead of the start of the pullback).
FIG 1: Global implied currency volatility (average of various pairs)
All of which begs the question: Whither the dollar?
In order to think about the dollar, it pays to analyse its trends using two perspectives/timeframes.
In particular:
Perspective number 1: The multi-year cycles
On the first factor (multi year swings), whilst the dollar has only been unanchored since the end of Bretton Woods (1971), there have been seven prior multi-year trends (we are currently in the eighth, starting in 2014). These are broken down as follows and can be seen on the chart below (FIG 2).
1. 1971 – 1979: The dollar drifted lower during the 1970s after the end of Bretton Woods as the US operated a loose monetary policy (and generated higher inflation than the likes of Germany/Japan).
2. Late 1970s to 1985: Volcker dramatically tightens monetary policy to control high inflation. Volcker was appointed as Chairman of the Fed’s board of governors in July 1979. His subsequent tightening of monetary policy drove the dollar higher through to 1985.
3. 1985 through to late 1987: Plaza Accord – an international agreement to weaken the US dollar (signed in September 1985).
4. 1987 - 1995: Initial Louvre Accord (Feb 1987) which was another international agreement, this time to halt the weakening of the USD. The dollar then drifted lower (within a wide range) until the mid-1990s.
5. 1995 – 2001: Period of dollar strength. The productivity miracle/surge temporarily raised trend GDP growth and led to tighter US monetary policy which supported the dollar.
6. 2001 – early 2008: Falling US dollar reflecting ‘lower for longer’ US rates/emergency US monetary policy (to deal with economic malaise/bust phase of the long cycle – see HERE for analysis of long cycles).
7. 2008 – April 2014: Initial USD strength on risk aversion during the most serious phase of the crisis (i.e. early 2008 through to March 2009). The dollar is then rangebound with major swings through to early 2014, with those swings largely determined by US bouts of QE (see FIG 3).
8. April 2014 to present: Dollar strength (except for 2017) as US monetary policy begins its normalisation process, starting with tapering in 2014.
FIG 2: The eight phases of the freely floating US dollar: 1971 – present
FIG 3: The US dollar & QE: 2009 – present
Interestingly, other than the Plaza and Louvre Accord phases, the dollar’s direction has been primarily about US monetary policy. Phases of loose monetary policy and dollar weakness accompany secular bouts of economic malaise (incl. 1970s and the recent noughties). Normalising monetary policy then typically follows those bouts of economic malaise (i.e. the early 1980s and since 2014). The normalising of policy drove a strong dollar trend (on both occasions). Finally the productivity miracle boom phase, 2nd half of 1990s, then led to tighter monetary policy and again a strong dollar.
Interestingly, in that respect, the monetary policy in the rest of the world is of secondary importance. The primary driver is US monetary policy.
For that reason (coupled with the models/technical analysis below), we think we remain in the strong dollar phase which started in 2014. Of the major economic blocs across the globe, the US is most advanced in its healing from the crisis. Those blocs consist of the Euro zone, Japan and China. It’s also most likely to be the first (and probably only major) economy to raise interest rates in the next 12 – 24 months (i.e. incl Japan and the Euro area), while it’s the only one of those three of the developed economic blocs which doesn’t have negative rates. Structurally (written about HERE), it is fundamentally stronger than the Euro area, Japan and China. Demographics in those other three regions are poor. Equally they all face significant economic structural problems, especially China and the Eurozone.
Perspective number 2: The trading models
From a trading model perspective, the USD has performed well despite a strong SELL signal in June last year (FIG 4). Indeed, despite that SELL signal, the trade weighted dollar has edged higher (over that timeframe). Our signal is put together using sentiment, market positioning and technical factors. Continued strength despite bullish sentiment, high net LONG positioning and an overbought signal, means that the dollar fundamentals are strong (i.e. as rates were normalising).
Since that time, that signal has been unwinding. In coming months, it’s likely that it will return to BUY levels. If it reaches BUY without giving back much (if any) of its strength that will be a bullish sign.
FIG 4: Longview Market Timing model (US trade weighted dollar)
Added to that dollar resilience, in the face of SELL signals, the dollar index has continued to remain supported (i.e. above) its long term trend line. In FIG 5 that is shown by the 200 day moving average….
FIG 5: USD candlestick chart shown with key moving averages
Equally a cursory glance at the euro illustrates that against the US dollar, it remains in a multi-year downtrend (which has been in place since 2008), and is only just at its long term mean currency rate……
FIG 6: Euro-US$ spot exchange rate (shown with long term mean and 200 day moving average)
Clearly currencies are notoriously difficult to forecast. Different forecasters use a mixture of a number of theories. Those include the analysis of fiscal and current account deficits, geopolitical trends, the purported deterioration of the USD’s reserve currency status, the ‘weaponization of the dollar’ theory, and others. In our view these are of minor importance compared to the key which is considering the direction of travel of the US’s monetary policy.
That monetary policy direction is in large part dictated by where the US economy is at, with respect to its long secular economic cycles. During secular bust phases (1970s and noughties), US equities are in a secular bear market, and the USD typically trends lower. During the secular bull phases, the USD typically experiences bouts of strength (albeit this was distorted by the Plaza accord in 2H 1980s).
FIG 7: US equity secular bull & bear markets and USD phases
Conclusion: Given our view that we are in a US secular equity bull market, and given the structural healing that has taken place in the US economy, and the associated policy normalisation that has begun, we view the long term trend in the US dollar as upwards. Recent price action, in the face of a SELL signal generated by the market timing model, reinforces that expectation.
Other publications out this week include an update on our tactical (1 – 4 month) equity market views, an analysis of the outlook for the Canadian economy (not too good!), and a shift in recommended positioning in our strategic asset allocation portfolios (i.e. 6 month+ timeframe). Links to all of those are laid out below.
Have a great weekend.
Kind regards,
Longview
Longview Research Recently Published
This week:
Global Macro Report, 4th Apr 2019:
"Canada: Recession risks building a.k.a. BoC easing likely" – see HERE
Tactical Equity Asset Allocation No. 183, 3rd Apr 2019:
"Start (re)Building Tactical Equity OW" – see HERE
Quarterly Global Asset Allocation Alert No. 7, 2nd Apr 2019:
"Remove US Treasury OW in Strategic Portfolios" – see HERE
Weekly Market Positioning Update, 1st Apr 2019:
"The message of positioning post the Fed meeting"
Last week:
Longview on Friday, 29th Mar 2019:
"Time to SELL bonds; cyclicals vs. defensives - extreme signals; the message of the yield curve; & why gold isn't about geopolitics" – see HERE
Longview Letter No. 122, 29th Mar 2019:
"The End is Nigh (just not yet) a.k.a. The Efficacy of yield curve inversions (and the message of other signals)" – see HERE
Commodity Fundamentals Report No. 92, 27th Mar 2019:
"GOLD: Geopolitics doesn't matter much (if at all)" – see HERE
Weekly Market Positioning Update, 25th Mar 2019:
"Currency positioning: EM vs. DM"