Dollar angst boils up at worst moment for markets

Asia Times ^

[FarCenter]

The investment world has seen no bigger widow-maker trade this last decade than shorting the US dollar. Yet recent volatility in the reserve currency has punters once again asking whether the great dollar reckoning is finally afoot?

No one knows, of course. The dollar’s sudden and sharp drop in recent days, though, has the whiff of exactly the sort of foreign-exchange shock for which markets have been bracing. As investors wait to see if things unravel, finally, it’s worth exploring how bad things might get.

For now, the dollar’s stumble can easily be explained by shifting considerations of interest rate differential expectations. As strategist Steven Barrow at Standard Bank puts it: “Our call for the dollar to enter a multi-year downtrend is partly based on the fact that the Fed’s tightening cycle will morph into an easing cycle, and this will pull the dollar down even as other central banks cut as well.”

News that inflation rose just 3% in June year on year, a third of the rate of increase a year before, suggests that the most aggressive Federal Reserve tightening cycle in three decades is winding down. The Bank of Japan, by comparison, is locked in place policy-wise, while the People’s Bank of China is in rate-cut mode.

Yet currency crises tend to come very suddenly. It doesn’t take much for a stumble to morph into the real thing. Once a critical mass of global investors starts taking a serious look at the dollar’s fundamentals, things could go south at warp speed.

Chief among the negative data points: a fast-widening current-account deficit; a national debt topping US$32 trillion; highly indebted households, buckling under the weight of hundreds of basis points worth of higher borrowing costs; President Joe Biden’s move to weaponize the dollar to punish Russia over Ukraine; trade friction with China; and a level of political bickering in Washington that has Fitch Ratings mulling a downgrade.

“There’s little evidence, however, of a sustainable uptrend in dollars at this point,” says J C Parets, founder and president of advisory AllStarCharts.com. “In fact, the majority of the data continues to point towards a lower US dollar.”

Strategist Masafumi Yamamoto at Mizuho Securities thinks the dollar will remain “under pressure” unless new evidence emerges that the US economy is “outperforming other countries.”

Economist Edward Bell at Emirates NBD says indications are that “the dollar’s prime position appears largely unchallenged, thus far. But there are developments that may yet drive a longer-term shift away from the US dollar, including the use of sanctions as a US foreign policy tool. There has also been a rise in bilateral agreements to settle trade in local currencies rather than the US dollar.”