Dollar rally may just begin: Richard Cookson

Yet I really see no reason to downplay the currency enthusiasm expressed earlier this year. Currencies are relative, not absolute, prices: they are formed by the relative economic properties of economies. Money markets are also – or should be – looking forward. Thus the question about the dollar should be rephrased in the following way: is the economic situation likely to favor the US over its trading partners in the coming months? On balance, the answer is yes. Some emerging currencies in particular look very weak.

While the pace at which the current account deficit has widened is worrying, such shortfalls are not bad in themselves: they simply reflect the willingness of foreign investors to grow the economy. Despite some recent softening, US economic growth prospects are better than those of other countries.

Putting COVID-19 aside, the problems for the rest of the world actually begin with China. Its economic success depends on rapid credit growth, so the government has leaned on banks to open loans whenever the economy has slowed. That game is ending. As noted by independent economist Andrew Hunt, China’s annual interest expenditure now exceeds the annual growth in its nominal GDP. Whether, in the long term, this results in an inflationary shock or Japanese-style debt deflation and austerity remains to be seen. Either way, real growth is slowing down and it’s starting to affect its business partners.

China has already relaxed monetary policy. This probably hasn’t gotten any easier due to persistently high inflationary pressures. This affects Europe, which relies heavily on Asian demand for its growth, as well as many emerging economies that do brisk trade with China. For its part, the US relies little on external demand.

Which brings us to relative interest rates. These are also in favor of the dollar. The Federal Reserve’s monetary policy is absurd at the moment. Deeply negative real rates are unreasonable in a hot running economy like the US. All they are doing is fueling excessive speculation, as evidenced by the stock and housing markets. They are also helping to ease inflationary pressures. Despite continued sluggish cues from the Fed on inflation, there is now little consensus on the wisdom of continuing with its ultra-lax monetary policy.

The longer this surge of inflation lasts — and I’m pretty sure it will last, albeit perhaps not as dramatically — puts more pressure on the Fed to end its bond purchases as soon as possible. Short-term rate expectations in financial markets are also likely to be high, thus boosting the dollar because European rates, to take one example, are unlikely to do anything.

Finally, there is the dollar supply to consider. The Fed has flooded the world with greenbacks to support the economy through the pandemic. M2, a measure of the money supply, has risen by $5.07 trillion or nearly 33% to $20.5 trillion since February 2020, according to data compiled by Bloomberg. That flooding has eased somewhat in recent months, but the influence of the Treasury Department running its account at the Fed in recent months has the same effect of spurring monetary growth, meaning that such actions Nearly $1.4 trillion has been pushed into the market. at the end of last year. However, the Treasury is due to close its account at the Fed this quarter.

With the dollar supply becoming more constrained soon, and relative economic growth and interest rates moving in its favor, the greenback is likely to get a boost. How fast the rally will be will depend on the risk appetite of the investors. You should not be surprised that this combination of factors was to produce ructions in the markets. If all this is likely to further weaken the euro, it makes some emerging currencies even more dangerous. The South African rand and the Turkish lira – neither of whose economies have a ray of economic honesty or political harmony – are likely to be fair in a very bad way.

Richard Cookson was Head of Research and Fund Manager at Rubicon Fund Management. He was previously chief investment officer at Citi Private Bank and head of asset-allocation research at HSBC.