Questioning The ‘Socially Responsible’ Dollar Narrative

Ok, so it’s worth checking in on the dollar.

I was waiting see if this morning’s post-JOLTS jolt would hold up and it generally has although we’re off the highs. Here’s a chart for some perspective:

DOllar

Be that as it may, bearish sentiment still hangs over the greenback like a collusion probe hangs over an incestuous White House, an ironic analogy given that it is indeed the collusion probe and the D.C. gridlock that probe has helped foster that is largely responsible for the downbeat sentiment.

This narrative is well established and a quick look at positioning suggests it’s a narrative that’s been accepted as something akin to gospel. Of course part and parcel of this is the juxtaposition with Europe, where the populist threat has for the time being been vanquished and the economic data has been decent (or whatever we’re calling “decent” in the post-crisis disinflationary regime).

Well sometimes when the narrative becomes gospel it’s good to question it and that’s exactly what Bloomberg’s Cameron Crise did this morning. The following serves as a nice counterpoint ahead of CPI data out later this week…

Via Bloomberg

Hell hath no fury like a bull that’s scorned, a sentiment playing out in the foreign exchange market this summer. While the U.S. dollar started the year as the darling of macro and currency investors across the globe, its failure to perform as expected has unleashed a wave of selling across a broad range of currencies. Newly minted dollar bears should be careful, however, because the underlying rationale for a secular decline in the greenback is weak and we’re entering an environment where it typically performs well.

  • There’s little doubt the dollar has been a grave disappointment to many investors this year. To be sure, underwhelming fiscal policy and inflation developments have delivered cyclical headwinds, and the improvement in economic conditions elsewhere has also provided an alternative to the U.S. as a destination for investment capital

Beleaguered

  • Selling this year has been close to relentless. Through July the dollar declined every month but February, and trend followers are very clearly short.

Trump2

  • The consistent bid for euros also suggests that long-term capital is being redeployed in the euro zone now that the economy and political environment are on a firmer footing
  • But it’s important to put the dollar’s recent decline in context. Secular declines have generally come about because of unsustainable external deficits that foreigners are no longer willing to finance. Despite Donald Trump’s chronic complaints, the U.S. trade and current-account deficits are both pretty modest — neither is a rationale for sustained dollar weakness
  • It’s tempting to craft a narrative that global investors are fleeing the dollar because of U.S. political considerations, and that may well explain some of the greenback’s weakness (after all, the euro’s rally kick-started when the establishment candidate won in France). However, there’s little empirical evidence that “macro socially responsible investing” is anything but ephemeral
  • While we’re all accustomed to seeing economic data smoothed via seasonal adjustments, in real life trade and investment flows occur in real time, delivering pockets of seasonality. Since the inception of Bloomberg dollar index data at the end of 2004, the dollar has tended to decline through the end of July and rally through the end of the year. A similar pattern emerges using data since 2010 (stripping out the financial crisis)
  • At this juncture, markets are optimistic about an ECB policy normalization and skeptical that the Fed will extend its tightening phase much beyond the end of this year. The prospect of a dollar-positive surprise on both counts is very real. Dollar bears should enjoy their time in the sun, because risks are increasingly skewing toward a bounce in the buck
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