On Wednesday, we (somewhat begrudgingly) documented the dollar’s steady grind to YTD highs – “begrudgingly” because explaining persistent dollar strength at a time when the Fed is dovish, risk assets are surging, crude is a-bubblin’ (sorry) and last month’s “growth scare” narrative has morphed into this month’s “cyclical reflation” story is a tedious exercise.
“The dollar rallying along with risk assets, bonds and oil is an anomaly and doesn’t make sense”, Morgan Stanley’s Vishy Tirupattur told Bloomberg on Thursday. “This combination is very confounding and seems very unsustainable to us.”
But is it really? – “confounding”, that is? I would argue it’s pretty simple to explain and, indeed, we offered a fairly straightforward rationale in “Long Live The ‘King’? Defiant Dollar Bedevils Doubters“.
Just because it’s explainable (at least with the benefit of hindsight) doesn’t mean it’s not a bit vexing, though. We’ll give Tirupattur that.
And as noted in the linked piece above, there is a sense in which some of the disconnects Morgan Stanley flags feel “unsustainable.” Here’s how we closed Wednesday’s post on this:
For the time being, markets seem content to ignore the contradiction between dollar strength and the euphoria across various risk assets. At some point, though, folks may lose their appetite for strange pairings.
The implication was that if the dollar continues to press higher, that would presumably weigh on risk appetite and, ultimately, short-circuit the “reflation” story. Nomura’s Charlie McElligott touched on that briefly in his Thursday missive.
“USD strength and the same legacy ‘Dollar Shortage’ liquidity issues are again springing up across FX markets”, he wrote, before imploring you to “remember that the Fed is still in QT mode for a bit longer [against] ongoing US issuance trajectory and the Fed Funds policy rate remains at 11 year highs.” He went on to list a series of market realities that are at least peripherally related.
- Inherently high-beta / high-yield ARS is breaking-down to new lows on default concerns as 5Y CDS breaks 1240—the highest cost of protection seen during the Macri administration
- TRY melting down again as the CB removed their pledge for further tightening if needed; Lira at lows vs USD since Oct18
- EM safe-haven Korea is too struggling, with Q1 GDP contracting -0.3% QoQ vs +0.3% expectations—the Won is now at 27 month lows vs the US Dollar
- Following the big inflation “miss” earlier in the week, Aussie has dropped below 70 to a new 3 month low vs USD as the same ol’ “Slow-flation” concerns persist
- The Dollar strength too sees USDCNH at 2m highs ( Offshore Yuan weakness vs USD)
We’ve touched on most of those bullets in dedicated posts (see here for the TRY discussion and here for the Aussie story, for instance). The Korea bit was interesting on Thursday. To the extent you consider the South Korean economy a bellwether, this isn’t great:
Set against consensus (for a 0.3% gain) that 0.3% contraction qualified as a “shocker” and served to throw (more than) a bit of cold water on the global turnaround story. South Korean exports are set to shrink for a fifth consecutive month (a reminder that despite an apparently imminent Sino-US trade deal, all is not well) and earnings have been disappointing. As noted above, the won sank to its weakest since March 2017.
With all of the above in mind, some new commentary from Nedbank’s Mehul Daya is worth highlighting. You’re reminded that Daya has spent the better part of the last 18 months weighing in dollar liquidity dynamics and he picks back up on that Thursday, touching on many of the issues raised above, either directly or tangentially.
“There are two major sources of USD liquidity, USD FX reserves stemming from global trade and the Fed’s balance sheet”, he writes, adding that “both of these sources of liquidity tightened in 2018, leading to a correction phase in risk assets across the world.”
The Fed’s decision to halt runoff and begin “QE-lite” later this year (or QE “heavy” tomorrow if Donald Trump had his way), will help, but Daya cautions that it’s probably too early to know whether global trade has bottomed out. The slowdown “was not just because of the US-China trade war; trade within Asia has slowed sharply and has not recovered yet”, he goes on to say.
As a reminder, the WTO recently cut their forecast for world trade growth. If you missed it, here’s a snapshot of the new forecasts versus the organization’s projections from September:
Next, Daya suggests that comparisons to 2016 might be a bit spurious. To wit, from the note:
Many commentators are comparing the current rally to the rally after the Shanghai Accord and expect more upside, and while this could happen, we need to point out that the rally did not appear out of thin air. Global central banks added USD2.9 trillion to their balance sheets in 2016 and 2017, fueling asset inflation. We remain of the view that the current rally is losing momentum and needs further stimulus to accelerate.
He goes on to present the following chart, which shows the “Dovish” versus “Hawkish” story count. The dovish side is, Daya exclaims, at an 8-year high, which suggests the rally is predicated a bit too much on “hope”.
Ultimately, the point is that the “dollar liquidity shortage” narrative is starting to pop up again, which is a bit disconcerting given the extent to which that same narrative was at the heart of last year’s EM tumult and, depending on how you couch things, can be a useful framework for explaining why some 90% of assets underperformed USD “cash” in 2018.