Market chatter around the prospect of a global accord aimed at halting the dollar’s inexorable run higher grew louder Monday, as the pound collapsed and China slapped a 20% reserve requirement on FX forwards in an effort to slow the pace of yuan depreciation.
The greenback has become the “only game in town,” as more than a couple of commentators put it. The dollar index is on track for a fourth monthly gain. It’s had just one down month in 2022 (figure below).
The surge may be overdone, but that won’t matter if risk-off sentiment gathers momentum and morphs into a panic. The same goes for US real yields. The moves are extended, but this isn’t an environment where technicals are running the show.
I’m a broken record: That’s not tenable. That sort of dollar strength ends in tears.
Morgan Stanley’s Mike Wilson agrees. In fact, he used the word “untenable” while suggesting some manner of “event” may be imminent. “What’s amazing is that this dollar strength is happening even as other major central banks are also tightening monetary policy at a historically hawkish pace,” he said. “If there was ever a time to be on the lookout for something to break, this would be it.”
I wholeheartedly agree, with the quibble that in my estimation, it’s not particularly surprising that the dollar continues to rise despite hawkishness from other central banks. You can’t “out-hawk” a determined Fed and thereby rescue your currency in a risk-off environment. The more perilous the circumstances and the more panicked the market, the harder it is to dissuade dollar strength. Dollar strength can feed into US reals (e.g., by pressuring breakevens), which can drive more dollar strength and so on. Short-circuiting that loop requires help from the Fed and Treasury.
“Last week saw no less than six central bank meetings in the G10 space, with five of the six involving rate hikes,” SocGen’s Olivier Korber marveled. “Among the five hikers, four currencies were sharply down [and] thanks to a hawkish Fed and amid fears of a US recession, the dollar kept its throne and doesn’t look likely to leave it.”
“The dollar has been benefiting from safe-haven demand on the back of rising global risk premia,” Goldman said. “The strong dollar has naturally prompted a variety of attempts from policymakers abroad to slow the dollar’s ascent — via faster rate hikes and the first bout of strong-sided JPY intervention since 1998 — which is still consistent with our ‘reverse currency wars’ thesis.”
Everyone wants a stronger currency in 2022 (even the SNB), because nobody wants imported inflation. The dollar’s rise is making that impossible, and because commodities are priced in dollars and raw materials prices have soared, the read-through for import bills is very onerous. Deteriorating terms of trade feed more currency weakness.
The simple Bloomberg screenshot (below) shows “a month in the life of the US dollar,” as Nomura’s Charlie McElligott put it. “Everything else is an emerging market as rate differentials widen and/or current account deficits soar in the rest of the world on ‘exported inflation,'” he wrote.
If you ask Goldman’s FX team, efforts by policymakers in other locales to arrest the dollar’s ascent are “insufficient to reverse macro factors, and more of a sign of discomfort with the speed of USD appreciation than a sign that the dollar is at the peak.” “In short, we still see more dollar strength ahead, and think markets will remain in the FCI loop until there are sustained signs that inflation is cooling and/or global growth is recovering,” the bank went on to say.
Again: The only thing that can stop this is coordinated action. Or, at the least, the appearance of coordination. The UK’s burgeoning financial crisis might be the final straw in that regard. “The [UK’s] political-economic gamble sen[t] sterling into a currency crisis that could potentially morph into some sort of global intervention scheme, as the dollar remains the only trade in town,” Bloomberg’s Vassilis Karamanis wrote Monday. The pound in “crisis mode” may mean a “Plaza Accord 2.0,” he said.
The problem, as noted here over the weekend in “Apocalypse Soon,” is that any Fed efforts could be seen as tantamount to easing, which is counterproductive to the domestic inflation fight. “We don’t have any indications at present that the US Treasury feels that coordinated action to weaken the dollar is on its agenda,” BNY Mellon’s John Velis said Monday. “We doubt the Fed would be [inclined] to adding USD liquidity at a time when it’s pursuing rate hikes and QT,” he added.
Still, Velis acknowledged that the strong dollar “is presenting problems for the rest of the world.” “Central banks have raised rates inexorably in recent weeks, but this hasn’t been able to blunt the dollar’s rise. Are we getting closer to a ‘Plaza moment’?” he wondered. “The USD real exchange rate is currently as high as it was at that time, but the spirit of cooperation doesn’t yet seem to be present among the [world’s] major economies.”
That recalls the discussion from “Pressing Shorts To Save The World,” in which I quoted BofA’s Michael Hartnett while (again) flagging the upcoming G20 meeting as a potentially history-making event.
Absent a circuit breaker, it’s hard to see what stops this train. “Rising stagflation risks and slowing growth global have put the dollar in an ascendant position,” Velis remarked. “We think this is still the case — alternatives across the G10 landscape present unappealing narratives.”
I don’t really have the capital to make much of all this volatility, I read you more to understand the world than to leverage it, but i did find a way to take advantage over the weekend — I really enjoy early Greek and Assyrian/Ionian history, and was able to pick up a really cool coin from ancient Miletus this weekend for a song. It cost me less than $100 shipped from europe, and it normally runs for more than 300 euros at auctions. Euro weakness really knocked a lot of bidders out of the action lately.
I thought it was a particularly poignant purchase as its from around 550 BC and depicts the flashing eyes of a panther peering out of the darkness — a symbol intended to warn the holder of this small lump of metal that they would now attract the evil eye, the malicious gaze of someone who had ill intentions towards them, of someone who coveted what they had (to the panther, their flesh; to other humans, the small lump of electrum).
As everyone rushes to hold more dollars, it makes me wonder if our modern currency could use a little symbolic inspiration from the earliest days of western civilizations first money.
So can we cap the dollar? Is that possible? China tied their currency to USD for years, can we do something like that and still raise interest rates? Any experts out there?
The market is screaming that the fomc is making a blunder sorry El-Erian and Summers…
It appears that the Fed is attempting brain surgery with a hammer and chisel.
Maybe Japan and the UK should change course rather than the fed.
+1
Fed has to stop hiking at a vigorous pace.
No hikes but continue QT. So what if the stock market has a party. Lesser evil.
International price discovery has become at risk.
I feel like a simple country stock farmer who has been thrown into the roiling waters of the big city macro trading pit.
At the risk of sounding very stupid, let me ask: if the Fed is forced to pivot or pause because it breaks something, and that “something” is GBP or JPY or Italian govt bonds or German Mittlestand, what will the implications be for US markets?
I’m thinking about the recent episodes of global capital crisis flight to USD (2008, 2020) and it’s not clear to me if the immediate consequences for domestic US consumers, companies, investors, or assets were, or were not, terribly negative?
Obviously in the bigger picture, the US benefits from an economically healthy and politically stable ROW, or at least G8. But in the short run, if you’re invested in SP500 and UST, would the positives of the Fed pivot/pause outweigh the negatives of whatever is broken if the breakage is overseas?
Seeking elucidation, welcome correction, even acerbic.
H. Mentioned in a previous article that the US was exporting its stagflation.
According to statistica
“Published by D. Clark, Jul 4, 2022
In March 2022, the global inflation rate for the consumer price index reached 9.22 percent, compared with 7.47 percent in February 2022. After reaching a low of 2.27 percent in August 2020, the inflation rate has steadily increased, with the most rapid growth occuring in late 2021 and early 2022”
The reserve currency exporting inflation is not the same as controlling inflation at a certain point. A very simplistic view from a fellow bumpkin. Price of oil and products derived from oil play a large part in all of this.
Also, just to toss in my half-cent, having updated my SP500 valuation model, assuming rF rises another 50 bp (10Y UST at 4.3%) and haircutting medium term FCF CAGRs by a full 10 percentage points, points to around 3300-3400 on a DCF valuation. Similar to what it’s been pointing to all year.
Alternatively, cutting SP500 revenue growth by half in 2022E and 2023E, cutting EBIT margin to prepandemic levels, and applying typical PE from periods when 10Y UST was in the 3.5-4.5% range, points to around 3250-3350 midrange.
I’d say both scenarios would imply and require a mild to modest recession in the real US economy of goods and services – a 1990 or 2001, rather than a 2008.
If we indeed have “only” another -10% or so to go on SP500, then depending on one’s tenperament, cautiously/opportunistically buying may make more sense than aggressively/indiscriminately selling.
Not investment advice, evidently, just my speculative musing.
By the way, if I remove market cap weighting from my DCF model, and look at the SP500 “equal weighted”, the DCF valuation looks fair here. Which implies that half the SP500 – the smaller half, generally speaking – may already be undervalued.
Mr. Heisenberg, What does this mean ? ? ? > ” … the Fed can always close bases”. TIA !
So, a basis. Bases is the plural. For our purposes here, just think of it conceptually as a spread between two things that “shouldn’t” be there or is larger than it “should” be or wider than desirable. Markets will usually look to arb those situations, but in a crisis they might linger or get worse, sometimes with deleterious consequences.
Thank you !
What you have seen today is a sell everything, go into US $ cash in a flight to quality- in this case the quality is really narrow, longer (like more than 90 day) US Treasury bonds not in this category. A few more days and there will have to be a response from the US Treasury/Fed. It is one thing for stocks and risky bonds/other assets to sell off, it is quite another for the US Treasury market to basically shut down and we are on the verge of that. If the UST bond market shuts down, it will be nearly impossible to value other securities as US Treasury rates provide the benchmark. No matter how determined the Fed is to quell inflation, a disorderly unwinding of the financial markets is not in the Fed’s playbook. That would connote a “run on the bank”, something central banks were designed to avoid, the next shoe to drop is deflation/depression.
I’m not qualified to comment on today’s action in the Treasury market, but looking out a few weeks or perhaps months, I do think there will be a rush into U.S. bonds at the first sign the economy has fallen into a real (as opposed to statistical) recession. Don’t know when that will be, but I feel like we’re getting closer….
Mfn, it feels like that is already happening. The 3 month yield has hardly moved this week, I feel like demand is holding the yield Down.
The U.S., with all its problems, seems to be in an oddly enviable position, maybe the best since GWB and Dick Cheney torched U.S. foreign policy credibility with their war of choice in Iraq. If I were at the policy table in Washington (or in a position to influence people who might be), I’d be pressing pretty hard for quid-pro-quos in the event of a Plaza 2.0-style agreement. I’m thinking not only of continued support for Ukraine in its existential struggle against Russian aggression, but also buy-in on a coordinated response to Chinese aggression against Taiwan. The UK and other Commonwealth countries (Canada, Australia, New Zealand), and Japan, Poland, and Romania seem like rock-solid allies at this juncture, but I wonder about the long-term commitment of countries like Germany, France, Italy, Turkey, and Sweden. A bit too real politik? Perhaps. But if others have decided to play that game, we would be foolish not to.
H-Man, it seems we are in a quagmire. If the Fed runs to save the world on the currency front, it will mean they have given up the inflation fight which simply is not an option. So it appears we are stuck with a rising currency until inflation takes a bow. Meanwhile, every currency in the world will be pounded (no pun intended).
On another front, what about all those profits American companies are booking in foreign currencies? It would seem those profits may prove to be illusory when those foreign currency transactions roll into dollars. Which then leads us to the question about repricing company earnings dependent upon foreign currency transactions.