The US Dollar: Great bull market is over
By Ryk de Klerk
JOHANNESBURG - The great bull market in the U.S. dollar is over as the US economy is finding itself in a much worse space than majors such as China and the Eurozone.
The U.S. Dollar Index’s long-term uptrend that started in 2011 has been broken decisively on the downside. The index of the value of the U.S. dollar relative to a basket of currencies of U.S. trade partners’ currencies, has lost 9% since March at the height of the COVID-19 crisis and looks set to fall another 6% in the not too distant future. Technical analysis, a powerful tool in the armoury of investment analysis, indicates that the eventual fall of the US dollar could see a total fall of nearly 17% from current levels before the currency could encounter solid support.
IHS Markit purchasing managers’ indexes (PMIs) for July indicate that the U.S. private sector output is stabilising but demand is faltering. The threat of an extended recession in the U.S. is real as the Trump administration’s calls on protectionism, the coronavirus and irrational decision-making have caught up with the US economy.
In stark contrast, the IHS Markit Composite PMI for the Eurozone pointed to the “fastest growth in over two years. The China Federation of Logistics & Purchasing (CFLP)’s Manufacturing PMI and the Caixin China General Composite PMI for July indicate that China is experiencing the fastest rise in new work since 2011.
The U.S. has no other option than to reflate the economy by further significant quantitative easing and extending lifelines such as the extra weekly unemployment benefits. Yes, the Federal Reserve will aggressively print money. Inflationary pressures are already evident and are likely to become even worse. On top of the steep fall in the external value of the U.S. dollar since March, the quantitative easing in the major economies such as China, Japan, the U.S. and Euro zone have resulted in stabilising the global economy and growth has started to reappear.
These factors have pushed base metal prices, measured by the Economist’s metal-price index, in major currencies such as U.S. dollars and euros to 24-month highs. The sudden turnaround in the global supply/demand equation due to the easing of lockdown measures and pump priming by central banks for instance caused copper inventories on the LME to fall to levels approaching the 2018 lows. The PMI for China also points to higher input prices as well as rising ex-factory prices. Inflation rates are therefore set to increase globally.
The upward pressure on U.S. inflation is not dissimilar to the 2008 Global Financial Crisis when the fall in the external value of the dollar contributed to higher inflation over the ensuing three years. The impact of the coronavirus on the US economy, amplified by the Trump administration’s mismanagement of the crisis thus far, could be far greater than what happened during the Global Financial Crisis.
Inflation in the U.S. is likely to overshoot on the upside as the global economic recovery gains traction resulting in elevated demand for raw materials and intermediate goods. The Federal Reserve simply cannot afford to hike interest rates too soon to support the dollar and suppress inflation as it would put the brakes on the economy. The U.S. dollar will need to adjust to a level where the U.S. can be competitive again and regain access to markets lost due to protectionism policies and pulling out of trade agreements.
In normal circumstances the outlook for US inflation would already be apparent in rising U.S. government long bond rates but quantitative easing inter alia involves the buying of U.S. treasuries to provide liquidity to stimulate the economy. U.S. government bond yields will therefore be kept artificially low. Due to the low interest rates and a falling dollar investors are likely to shun U.S. treasuries and look elsewhere to protect them against the new “not so safe-haven status”, my quote, of the greenback and get decent returns.
As things stand, it is evident that the global economic recovery is slowly gaining momentum with China at the forefront. That, together with a crash in the U.S. dollar and the overshoot of inflation in the U.S. could have important implications for global capital markets.
Equity markets in developed economies are likely to be driven higher by sector rotation, increasingly in favour of economic cyclical equities. In the U.S., dollar hedges such as multi-national companies and exporters of goods and services are likely to outperform on a weak dollar. New highs in stock markets are on my radar screen.
Bond yields in the major developed economies are likely to remain close to zero due to continued central bank intervention in the major economies to ensure a sustained recovery. The search for yield is likely to lead to significant capital flows to emerging market bonds, specifically high yielding government bonds in commodity-related economies.
As commodities such as oil, base metals and other materials are priced in U.S. dollars, the outlook for commodities is positive as increased global demand due to the global recovery from the coronavirus crisis and the dollar’s fall from grace are likely to underscore prices.
The outlook for emerging market currencies is therefore positive, specifically against the U.S. dollar. Growth prospects in developing countries are likely to turn for the better while imported inflation could remain in check.
With the bleak outlook for the U.S. dollar, central banks are likely to exchange some of their US dollar reserves for gold as the metal’s price strength will most probably reflect the US dollar’s weakness. The recent surges in gold, silver and even cryptocurrency prices probably bear testimony to the market’s anticipation of the possible crash of the greenback.
The US dollar’s status as the world’s primary reserve currency and safe-haven is threatened by the dollar entering a major bear market. China’s yuan and the euro are likely to emerge as primary reserve currencies at the cost of the US dollar while gold will remain a non-negotiable asset in countries’ reserves.
My rands may buy more U.S. dollars in future!
Ryk de Klerk
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment advisor for advice.