So why have I decided to lead with this famous quote? Well the answer is that what held true in 1971 still holds true 47 years later. In 2018, the Dollar is still the reserve currency of the world, which means we still live in a US-centric world, with trade flows and markets still dominated by its strength, or otherwise.
Calling the direction of the Dollar is notoriously difficult, but I thought I would share one of the views that we are currently seeing in the markets.
The following information was gleaned from a recent meeting I had with Nedbank Corporate Investment Bank, a stockbroker based in Johannesburg. They are unashamedly bullish on the Dollar and this view is predicated on many factors, chief amongst them the changing tide from quantitative easing to quantitative tightening, led by the US Federal Reserve. It is true that the Fed has been raising rates for a while now and another four increases are predicted over the coming 12 months, but this is not where Nedbank focus their attention. Instead, they are more interested in the great unwind of the Fed’s balance sheet, which has already shrunk by about $200 billion since their change in policy direction, with a further reduction of $500 billion predicted in the next twelve months. If you multiply this by the money multiplier, referred to as the velocity of money, then that number is many times larger in terms of global flows. Tightening global liquidity, ceteris paribus, will lead to further Dollar strength, as the demand for the US currency outstrips supply.
But it’s not only the reduction in the Fed’s balance sheet that makes Nedbank optimistic about Dollar strength; it’s also the fact that global trade is already slowing and will no doubt slow down even more if trade tariffs escalate from current levels. Slower global trade means a smaller US current account deficit, which, along with Fed tightening, will result in fewer Dollars in circulation. Add in a new-found self-sufficiency in energy (soon to be a net exporter!) and you have even more reason for the current account deficit in the US to narrow and even fewer Dollars circulating the globe.
In the very short term, however, Nedbank are of the view that the Dollar could take a breather and even weaken a little. From a purely technical perspective, having failed to stay above the key level of 95 on DXY spot index and after the strong gains since late January, a retracement is probably to be expected. They are, however, quick to point out that this is a short term call and their view longer out remains decidedly Dollar bullish
Historically a strong Dollar has been very negative for emerging markets and as we have seen over the last few months, this time has been no different. The huge falls in the Argentinian Peso and latterly the Turkish Lira are symptomatic of Dollar strength and a number of strategists are now comparing 2018 to the Asian Financial crisis. Back then, it was led by the Asian Tigers trying, but ultimately failing, to defend their currencies’ official Dollar pegs, which (happily) is not the case this time around. At the same time, a number of emerging markets today have massive Dollar debt and thanks to the carry trade ( which is now reversing ) , capital flows could return to the US as the Dollar strengthens
In the short term, we also think the Dollar could reverse course and weaken somewhat, especially if there is a softening in the ongoing Sino-American trade hostilities. Longer out, however, the arguments in favour of a stronger Dollar remain valid. This is predicated on the US continuing to tighten and with US growth starting to show some signs of weakness(especially on the housing front) and trade wars impacting global growth, then the Fed could take their foot of the quantitative tightening brake. But until growth really starts to slow, expect a stronger Dollar and trickier times ahead, especially in the emerging markets space. (A caveat to this is that not all EMs are equal, so this is not a blanket avoid for all EM assets).
Download: Weekly Comment – September 05 2018 – JB