Jeff Gundlach may have been wrong about the imminent Treasury short squeeze that purportedly had the potential to take 10Y yields down to 2.25%, but he was definitely right when he said the following last week about the stretched long position in the dollar:
Speculative positioning is way long the dollar and now they’re wrong.
As a reminder, here’s what that spec positioning looks like:
“I don’t think we’ll have new highs in the dollar without first seeing new moves to the downside”, Gundlach said, in the same webcast from which the quote above is taken.
Since the dollar hit new highs in early August, folks have been pounding the table on the absolute necessity of the greenback taking a breather. Further dollar strength, it was argued, would tip emerging markets into an outright crisis and the generalized tightening of financial conditions implicit in a stronger greenback would continue to weigh on ex-U.S. risk sentiment which could, finally, boomerang back to U.S. stocks.
The dollar did take a breather in mid-August, but the reprieve for EM would prove fleeting.
A string of ebullient U.S. macro (e.g., 14-year high on ISM, ridiculous prints on small business sentiment and an upbeat August jobs report) conspired with fresh turmoil in EM (e.g., more pain for the Argentine peso, rupiah at multi-decade lows, South Africa recession) to catalyze a dollar rebound, reigniting fears that the ex-U.S. malaise was set to worsen.
Well, “for whatever reason, Ray, call it luck, call it fate, call it karma”…
…the dollar has decided that this time around, soaring U.S. yields and trade tensions are not USD positive, and that, in turn, is positive for risk sentiment.
Here’s your mid-August head fake, your early September resumption of USD strength, and the reprieve we’ve all been waiting for:
Again, that is good news for risk sentiment. Here’s Nomura’s Charlie McElligott:
The crowded U.S. Dollar long is “in trouble,” making a new low for September and now back near July levels as it breaks lower through both 50- and 100- DMAs—all despite the market’s recent “upgrade” towards the Fed 2019 “dots,” which is “telling”
Increasingly “hawkish” ECB movement of late (both Draghi’s press conf, recent comments from Vasiliauskas, and the upcoming Oct “taper-then-end” of QE in Dec) also boosting the Euro (recall, 58% of the DXY), as ERZ8ERZ9 has added 3.5bps of implied 2019 hikes since the beginning of the month
There are other “weak Dollar” catalysts too: 1) the very strong UK data of late allows for further “hawkish pivot” by BoE (GBP as 12% of DXY), in addition to 2) a lower-delta but growing belief that the BoJ can finally “up” their own hawkish rhetoric now that Abe won his third straight term as head of the LDP Thursday (JPY as ~14% of DXY), particularly allowing JGBs to move closer to the upper level of new YCC range and, in theory, helping to steepen the curve (which in-turn boosts the Japanese banking sector—notice TOPIX Banks +6.8% since Sep 12th)
This “Return of Policy Convergence” theme means that many G10 currencies are about to enter “catch-up” mode (vs USD downside) after languishing against the super-charged U.S. Dollar YTD, because they have to take advantage of this final phase of the Fed hiking-cycle to execute their own normalization—especially with Europe still needing to get back (just) to the zero-bound!
As noted repeatedly, this U.S. Dollar fatigue then continues to offer DEVELOPED EQUITIES UPSIDE and relief / tactical upside for EM and Commodities / Commodities-linked plays (e.g. Eurostoxx Basic Resources now “up” seven consecutive sessions for the first time since January, partially-too boosted by the perpetual market belief in “limitless Chinese stimulus” options to offset slowdown and potential tariff negative impacts)
Meanwhile, the bond selloff has accelerated (see here). MTD, developed market yields are markedly higher pretty much across the board:
It’s at least possible that i) renewed faith in the reflation narrative (thanks China!) and ii) the prospect that the monetary policy convergence theme (and maybe even the economic convergence theme) is about the reassert itself, are together creating alternatives to U.S. debt, thereby ushering in a return to the dynamics that persisted in late 2017/early 2018 when worries about the U.S. fiscal trajectory and the notion that U.S. protectionism is a weak dollar policy by proxy, together prevented the greenback from responding to sharply higher U.S. yields and increasingly favorable rate differentials.
Whatever the case, risk assets will take it at this point, because as nearly everyone has been shrieking about for weeks on end, the surest path higher for risk assets of all stripes going forward is a weaker dollar.