Speculative positioning is way long the dollar and now they’re wrong.
That’s from bond king for the post-Gross world, Twitter celebrity and man who isn’t afraid to show up at Sohn dressed in a Jack Nicholson Joker costume, Jeff Gundlach.
The quote is from a September 11 webcast, his four-hundredth such event of 2018, and as noted at the time, Jeff is probably right.
Of course if you ask Gundlach, Gundlach is always right. That’s why Jeff’s Twitter handle is @TruthGundlach. He is synonymous with “truth” and thus anything which comes out of his mouth is by definition correct, even when it is demonstrably incorrect, like, for instance, when he claimed the stretched spec short in the 10Y presaged a “monumental short squeeze” only to look on as yields accelerated to their highest since 2011.
Anyway, the bearish dollar view now seems to be the consensus. Last week, Morgan Stanley was out with a lengthy note that carried the decidedly unambiguous title “Time to Sell USD” and on Sunday evening, BofAML’s Michael Hartnett said he too is bearish on the greenback. To some, Friday’s comments from Richard Clarida suggest the Fed is likely to pause sooner than Jerome Powell previously indicated and that would likely play dollar negative to the extent Fed hikes have been one of the key pillars of support for the greenback in 2018.
Well, you can now add Goldman to those calling for a weaker dollar in 2019. The bank’s assessment is based on U.S. growth slowing and, more generally, all of the factors that pushed up the greenback in 2018 fading away.
“On a Q4/Q4 basis, our US economists forecast a slowing from 3.1% in 2018 to 2.0% in 2019 [and] as we have noted in recent research, slower US growth tends to result in lower Dollar returns (especially vs G10, but to some extent vs EM as well) even when US interest rates are rising faster than expected”, the bank writes, adding that “if US growth slows down but growth in the rest of the world picks up the Dollar tends to depreciate outright—again by larger amounts against G10 currencies.”
If that’s not straightforward enough for you, Goldman spells it out:
In 2019, we expect a scenario like this: significantly slower US growth but a mild acceleration in non-US growth, which historically points to Dollar depreciation.
Goldman goes on to cite stretched positioning (so, the same thing Jeff Gundlach cited back in September) and the bank also reminds you that according to their model, “the trade-weighted Dollar is about 11% above its long-run fair value level”. Here’s net spec length along with the BBDXY, just to underscore how folks are still piled in on the long side:
Goldman also says “bond fund managers appear to have covered most of their Dollar shorts built up in early 2018.” Here’s their proxy for that, annotated:
From there, the thesis falls neatly into place. Assuming Jerome Powell is indeed forced to take a pause (or perhaps even do a “hard stop”) midway through 2019, that will likely coincide with other developed market central banks pushing ahead with normalization, thus closing the monetary policy divergence and undercutting the rate differentials pillar. Goldman also flags the Trump administration’s palpable disdain for an overly strong currency.
So, what are the risks to this view? Well, those are equally easy to surmise. If slowing U.S. growth is accompanied by a deep slowdown abroad, the dollar could benefit from safe haven flows into Treasurys. Goldman also cites the possibility that inflation continues to rise stateside, forcing the Fed to remain relatively hawkish irrespective of growth concerns. And finally, the bank mentions the possibility that ECB normalization does not proceed as planned.
There you go. Any questions?