US Dollar: American Phoenix by John Mauldin, Mauldin Economics.
“Just a little patience, yeah…”
– Guns N’ Roses
Last week the FOMC essentially removed forward guidance and placed all options back on the table, and at the end of the day they’ve opened the door for further tightening. As Yellen recently explained in advance, the removal of the word patience from the Fed’s guidance amounts to fair warning to the rest of the world’s central banks: an interest rate hike is on the horizon. Govern your actions accordingly. (My personal guess, for those interested, is September, with the Fed proceeding exceedingly slowly and cautiously thereafter.)
The bigger story here is the sustained strength of the US dollar, which has traded wildly in the FOMC’s wake. A correction to the one-way trading prior to the meeting was well overdue and could last some time, but then the dollar strength will resume. (Euro) Parity or Bust! My young colleague Worth Wray and I have been writing for some time about the risks this trend poses, to emerging markets in particular, and now it seems that nightmare could happen sooner rather than later.
We’re already seeing profound FX pressures on countries like Russia, Brazil, Turkey, and South Africa, among many others; but, while clearly exacerbated by the strong dollar and/or weak commodity prices, recent stress in various emerging markets appears to have more to do with internal troubles than external shocks. Nevertheless, the dollar’s strength has not been fully absorbed by EM economies, so a BIG, broad-based, dollar-driven adjustment may be yet to come.
Until this Wednesday’s FOMC press conference with Janet Yellen, the growing consensus was that an eventual interest rate hike would lead to an even stronger USD. Now it seems most observers, including our own Jared Dillian, are doubting that a rate hike will come this summer… or anytime soon.
Worth and I have a different view. We believe that Federal Reserve Vice Chair Stanley Fischer has carefully laid out a framework for interpreting the FOMC’s opaque communications as the committee moves closer to a rate hike. In a speech last October, Fischer made it clear that the Fed would “recognize the effect of (its) actions abroad and … minimize the negative spillovers (those actions will likely have) on the global economy” by clearly communicating its policy intentions in advance. If you read between the lines, the only way the Fed can give foreign central banks the opportunity to prepare for the likely FX shock that would follow a rate hike is to send the message in a way that the market does not immediately understand as overtly hawkish. This week’s announcement makes perfect sense when looked at through that lens.
Translation: while the FOMC’s decision to hike interest rates remains data-dependent, the Fed has opened the door for further tightening as soon as June 2015. That could be terrible news for a number of emerging markets, but none of those countries can credibly complain that the Fed is responsible as capital flees their economies in search of safety and more-attractive risk-adjusted rates. Emerging markets are not a homogenous group, but even the best positioned countries like the Philippines are at risk in the event of a broad-based contagion. We’ve seen that dynamic play out repeatedly in the 1980s, the 1990s, and the 2000s. It may be time for another hurricane.
With our expectations on the table, Worth and I still have to ask… what if we’re wrong? What if the dollar doesn’t strengthen? We’ll consider that scenario in today’s OTB.
It’s a real pleasure for me to introduce today’s author, because this OTB is also the perfect opportunity for an announcement I’ve been wanting to make for some time: Jawad Mian has brought his excellent research service, Stray Reflections, to Mauldin Economics. You can learn more about his service here. His “transparent hedge fund” approach to investment research is unique, well-reasoned, and decidedly non-consensus. And his prose is unrivaled.
Today’s OTB is taken from Jawad’s top 10 investment themes. These are the themes around which he builds his portfolio. I agree with many of his ideas, but I offer up this particular piece as an example of one where I remain unconvinced, if not in outright disagreement. Yet… Jawad makes such a strong argument for the dollar’s weakening. We have exchanged emails and dueling notes of late (but in a very collegial fashion).
I have to admit, I am NEVER comfortable when this much of the crowd agrees with my view, as they seem to now. A serious correction of the recent trend in dollar strength is clearly due, but what if – as Jawad argues – we are seeing a major shift to an entirely new macro regime?
It’s worth noting that Jawad made this weaker dollar call several months ago. HSBC analysts and others are beginning to agree with him. The US dollar is the single most important factor in global macroeconomics; so do your homework, consider the antithesis to your closely held beliefs, and ignore Jawad’s thoughtful analysis at your own risk.
I was in Switzerland for the last week, meeting clients and speaking in Zürich. I kept asking the question, “Where is Draghi going to get €60 trillion in European bonds, month after month?” He is reportedly already behind the curve for this month’s purchases. I get no satisfactory (to me) answer. Maybe he does, but he wants to buy more than governments are issuing, and no pension company or insurance company is going to be able to sell him their bonds if they have a positive yield. Maybe he gets creative in what he buys. I will write more about this over the next weekend, but we are in the Twilight Zone for bonds. French yields are negative out to five years, and to get 1.5% you have to buy a 50-year French bond? Can anyone do that and seriously be considered a prudent fiduciary? Have you looked at France’s balance sheet and total commitments, not to mention the country’s politics? And don’t even get me started on the rest of Europe. Half of Northern Europe’s debt has negative yields.
I had the very real privilege of having dinner with William White, former chief economist of the Bank of International Settlements and currently consultant to seemingly everyone. He will be at my conference this year as the final speaker, and it will be a very impactful speech. On several occasions during dinner, I got him to agree to say in public what he said in private Tuesday night. I have long been a fan of his candor and style, and that evening I felt like a student. He is now my favorite (ex) central banker.
I want to thank so many of you who wrote to me expressing your condolences about my Mother. It meant a lot. Truly.
My sister flew in from Victoria Island, where she lives with her sons. I cornered her the first night she was there and told her that her other brother wanted us to sing at the graveside the lullabies that mother sang to us as children when she put us to bed (and which we all vividly remember). I tried to convey the clear impression that I thought it was