You’d be forgiven for throwing in the towel on the long USD trade.
After all, Goldman has. Twice:
- 3 Weeks Later, Goldman Thinks “Fuck It” Probably Still Best Way To Think About USD
- “The Outlook Is Quite Dim” — Goldman Reiterates “Fuck It” Call On Dollar As Russians Take Over White House
Despite the fact that the Fed is set to further normalize policy (and maybe even the balance sheet), this year’s “sure bet” trade has been anything but.
Part of the problem was the dovish lean the Fed put on the March hike, but really, questions about the viability of the Trump agenda and in fact, about the viability of this administration itself, have served to undercut the greenback.
Meanwhile, things are looking up from an econ perspective in Europe and a sustained uptick in realized inflation in the US has proven elusive. Political turmoil in Italy and a still-dovish-sounding Draghi notwithstanding, it’s not far-fetched to think that perhaps the policy divergence theme that was supposed to support the dollar may ultimately be thrown into question should the ECB get more hawkish while the Fed dithers and the US curve continues to flatten.
Really, all you need is one chart to conceptualize how this trade has gone:
But if you’re the type who believes the night is darkest just before the dawn, then you may enjoy the latest from Bloomberg’s Cameron Crise who on Thursday says “the dollar’s about to start flexing its muscles”…
Dollar bulls have had a rough go of it lately. After peaking in early January the greenback’s been on a one way train lower, one of many popular “Trump trades” gone awry. While there may have been a solid rationale for the dollar’s decline, I’d be wary of chasing it here. Conditions are brewing for a revival of the dollar’s fortunes.
- Let’s be clear: there are good reasons why the dollar has fallen in 2017. Traders started the year long dollars and brimming with confidence on the U.S. economy and the reflation trade. As domestic growth and inflation data have disappointed, the prospects for meaningful positive reform have also receded. Small wonder that positions have been flushed as expectations recalibrated!
- However, the shoe now appears to be on the other foot. Model-driven funds are short dollars and macro traders have largely given up on the long-dollar trade. Europe and emerging markets are the hot investment destinations du jour. Even “perma-long” USD/CNH positions have been stopped out this week. When sacred cows get taken to the abattoir, that’s usually a sign that position-squaring has run its course.
- Of course, it’s easy to dislike the dollar when economic data consistently disappoint. However, it’s important to remember that expectations eventually re-set and that economic surprises are mean-reverting.
- I analyzed the Citi U.S. Economic Surprise Index over the past five years and counted nine meaningful declines over that period. The current one, dating from the March 15 peak, has matched or exceeded the length and magnitude of prior declines, on average. In other words, we should probably expect U.S. data to start positively surprising before long…providing support for the dollar.
- If and as U.S. data improve, there is ample room for interest rates to adjust higher. Market pricing for the Fed remains modest and bond yields are too low if the Fed delivers anything close to what they have projected. Moreover, the dollar looks cheap even based on the current level of yields.
- Finally, every trader likes a good technical set-up. Bloomberg’s dollar index is hovering just above a level that has proven to be staunch support since autumn. Those who buy dollars here will know fairly quickly if they are wrong.
- Fading market consensus has been a profitable strategy for much of the post- crisis era. Since December, the dollar’s gone from Charles Atlas to a 98-pound weakling. The time is ripe for the buck to fight back.