“It’s all about horseraces now”, Deutsche Bank’s George Saravelos declares, kicking off a lengthy FX strategy outlook with a line that accidentally conjures Fletch in my 80s mind (“It’s all ball bearings nowadays.”)
Although the dollar has found its footing over the past several sessions, there are clear long-term headwinds for the greenback, not least of which is the US fiscal/monetary policy conjuncture.
All summer, deeply negative real rates in the US served to undermine the dollar, while supporting risk appetite and rescuing the world from the acute conditions that prevailed in mid-March when a panicked dash for USD cash undercut nearly every asset class, including gold.
For Deutsche’s Saravelos, the dollar now faces “the worst policy mix since Bretton Woods”, and the outlook isn’t likely to improve regardless of the election outcome.
“The real rate differential between the US and the rest of the world is at the lower end of its post-2008 range [and] this is historically associated with persistent dollar weakness”, Saravelos writes.
He reiterates that the US is now running the largest peacetime deficit ever, and when you throw in the current account deficit, you end up “the worst twin deficit on record too… an important dollar negative”.
When it comes to November, Saravelos says a blue wave would be the most detrimental for the greenback “because it would lead to the largest fiscal stimulus, focused on lower-income households [which] would widen the current account deficit via higher consumer spending, and would discourage US portfolio inflows due to higher taxation on capital”.
Don’t let the “focused on lower-income households” bit be lost on you. Although Saravelos’s take is neutral from a political perspective, I’ve been keen to emphasize over the past several months that we’ve reached a point beyond which the only way to break the cycle of financial repression, asset price inflation (with little to show for it in the real economy), and ever expanding wealth gaps, is via a more redistributive tax regime and fiscal stimulus accommodated by the Fed.
In my view, risking inflation and the possible loss of some purchasing power is (more than) worth it. Otherwise, we’re doomed to persist in an inegalitarian spiral in perpetuity until there’s some manner of societal breaking point. We may already be there. (Again, that’s me editorializing, not a summary of any analyst’s opinion.)
When it comes to the vaccine, Saravelos writes that “unless Moderna is the only vaccine to finish the race, most other candidates are likely to be broadly distributed globally”.
That’s obviously a good thing for humanity, but he argues it will be negative for the dollar as “COVID-sensitive equity sectors” which were left behind in the tech-centric summer rally will play catch up as global growth is upgraded. A pro-cyclical equity rally “should be negative for the dollar as a counter-cyclical asset, especially against EM”, Saravelos says.
Uncertainty is, of course, running high, but for Deutsche’s FX strategists, “a clear theme [is] emerging”. That theme is this: “The US policy mix is already very negative for the dollar and the most likely outcome” of the race for the White House, the race for a vaccine, and the race to keep economies open (which they call “the three horseraces”) “will be to make the mix even worse” for the greenback.