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What is Driving the Dollar?

Marc To Market's picture




 

There is a high degree of uncertainty in the global markets.   How deep into negative territory can nominal bond yields fall?  Has oil bottomed?  Are deflationary forces deepening? Will Greece remain within EMU, will the monetary union be stronger or weaker, as a result?

 

Returning to basics may be helpful in providing a ballast.  The investment climate was  shaped by the divergent economic outcomes from the different policy responses to the financial crisis.  The US and UK are ahead of the other high income countries.  Their central banks are expected to hike rates first, with the Federal Reserve going later this year, and now it appears likely the the BOE follows suit next year.

 

In the mean time, the ECB continues to ease monetary policy, and its sovereign bond buying program will begin next month and run through at least September 2016. The Bank of Japan continues its very aggressive unorthodox monetary policy.  It is expanding its balance sheet by 1.4% (of GDP) a month.  The BOJ targets core inflation, which includes energy, and it then adjusts for the sales tax increase last April.  By its own measure, despite the unprecedented pace of monetary easing, price pressures have been moving in the wrong direction. Many expect further easing later this year.

 

Two elements have been called into question.  First, the US economic growth has cooled after expanding around twice the pace of trend growth (labor force growth and productivity gains).  The 2.6% pace in Q4 14 is likely to be revised lower, possibly below 2%.  Growth in the current quarter is tracking around 2.2% according to the Atlanta Fed's GDPNow model.

 

Second, the decline in oil and interest rates, and the adjustment in the foreign exchange market are lending support to the world economy.  As we have noted,  the euro zone's real sector and financial data have been improving.  Money supply and bank lending have continued to recover.  Last week Q4 GDP was reported at 0.3% quarter-over-quarter, which was a little better than expected.   The flash PMIs for the eurozone will be reported at the end of the week ahead.  It is expected to confirm the modest pick up in activity has continued.  

 

Of note, the German locomotive got back on track, expanding 0.7% in Q4, which is faster than the US.  The stock market's nearly 12% advance this year will help lift the ZEW survey of investor sentiment.  Japan's April-September contraction ended as well.  We are likely to learn in Tokyo early Monday that the Japanese economy expanded by around 0.9% in Q4.

 

As the contraction in Q1 14 GDP did not prompt the Fed into changing its tapering course, we do not think that the return to trend growth from a quicker pace will prevent a midyear hike.  We continue to expect the forward guidance at the March FOMC meeting to evolve to confirm this as a possibility.

 

In mean time, the market will scrutinize the January FOMC minutes in the middle of the week. Appreciating that Germany and Japan grew faster than the US in Q4 will encourage the realization that the reference to international developments in the FOMC statement will also not preclude a midyear hike.

 

The Bank of England and the Reserve Bank of Australia also release minutes from their meetings earlier this month.  In both cases, though, more recent comments from officials have superseded the minutes.  The BOE's Quarterly Inflation Report acknowledged the downside risks to near-term inflation but expects the pace to pick up by the end of the year.   Growth forecasts for 2016-2017 edged higher.

 

Carney's reference to the central bank's willingness to cut rates if necessary is not the base view. Nevertheless, the December 2015 short-sterling futures contract rallied, with the implied rate falling by 16 bp in response.  Even more surprising then was sterling 2 cent rally against the dollar.  Over the past year, the 60-day correlation between sterling and the December short-sterling futures contract is nearly 88% (on a purely directional basis).

 

However, this week's UK data will include a likely steep fall in headline inflation and soft retail sales, which may not change these new dynamics.  The employment report is not expect to show much of a change in the pace that the unemployment queues are falling or weekly earnings growth.

 

The RBA's monetary policy statement likely steals whatever thunder there would have been in its minutes.  With a 65%-70% confidence, the market is pricing another rate cut, and the RBA did not lean against such expectations. The Australian dollar has fallen 5% this year and about 16.5% over the past six month.

 

The market is taking the Australian dollar (on a trend basis) in the direction that RBA Governor Stevens has indicated appropriate.  With this pace of adjustment, there was no need for the RBA to push it further or faster.  The market has taken the bit and is running with it.  That said, the downside momentum has faded, and technical factors warn of potential corrective forces.

 

The most interesting central bank meeting report will come from the ECB.  Until now the ECB has been reluctant to provide some record of its policy making discussions.  This is expected to change this week.  Neither the content nor format is understood yet, except that individual names will not be cited.

 

It was at the January meeting that the ECB decided to expand its asset purchase program from about 10 bln euros a month to 60 bln, which will include sovereign bonds.  While recognizing this is an important step in the transparency of the ECB, it is also a new channel of communication. Since the record can only be a partial summary of what happened, the ECB, like other central banks, will reveal what it wants.

 

The ECB is also expected to review its ELA authorization to Greece. Some claim the ECB's decision to no longer accept Greek government bonds as collateral was aimed not so much at Greece as to force both sides together.  However, it took place immediately following Draghi's meeting with Greece's new finance minister and not after Draghi's discussions with Berlin.  Surely the two sides would have been engaged in tough negotiations even if the ECB continued to accept Greek bonds.

 

Moreover, it assumes the ECB is some how impartial.  For Pete's sake, the ECB is part of the Troika and is an official creditor.  It is not just Greece that is critical of the Troika as such, but the European Court of Justice and the EC have recognized the conflict of interest for the ECB.   Indeed, there is no compelling reason the ESM does not buy out the IMF and the ECB's share of Greek debt.  Those new ESM bonds would be eligible for purchase under the ECB's new bond buying program.

 

Brinkmanship tactic require going to, well, the brink.  It was Eurogroup head Dijsslbloem that claimed the February 16 meeting of European finance ministers was some kind of deadline.    That does not really seem to be the case.  In any event, the market appears to be growing more confident that a compromise will be found, despite the fall in Greek bank deposits (some of the funds appear to be going to foreign banks in Greece).

 

The Greek stock market is up almost 30% from the late-January lows, and more than half was recorded in the last two sessions.  Greek's 10-year bond yield fell about 85 bp last week and is now down nearly 200 bp since the end of January.  The  3-year bond yield peaked last week at almost 22% and finished last week a little below 16%.

 

Commodity prices generally, and oil prices, in particular, have moved higher over the past couple of weeks.  Although the technical tone is favorable for additional near-term gains in oil, we think it is premature to think that the first bounce since OPEC's decision, not to cut production in late November is the bottom.   Speculators in the futures market have been accumulating a larger gross long position since the end of November.  

 

It is true that hostilities in Libya have reduced its supply and that the US rig count continues to fall quickly. Libya was producing around 350k barrels a day in January, but this may have dropped below 200k barrels now.  This trims the daily surplus that is still excess of one mln barrels a day and storage capacity is being filled.  

 

The US oil rig count has fallen by a third since October's peak.  Oil production last week is estimated at 9.2 mln barrels a day, a record and a 40k increase from the previous week.  The rig count is expected to continue to fall, and the historical experience suggests that the rig count is only half way to where it will fall in the coming months.   Global output has not peaked.  

 

Lastly, trying frame the state of monetary policy as a currency war does not yield fruitful results.  It is a strange war that the belligerents do not recognize.  Journalists and some analysts call it a currency war, but no one else.  The US, the EU, Japan, and even the BRICS have not accused any country of engaging in a beggar-thy neighbor strategy.  

 

It is a strange war that has such an obscure objective.  The three weakest currencies over the past six months are the Russian ruble that has lost 43% of its value, the Colombian peso which fallen 21%, and the Brazilian real which is off 19.5%.  All three raised interest rates last year (Russia cut rates this year).  Are they winning the currency war? Really?  

 

Sweden became the latest European central bank to adopt a negative official rate.  Some accused it of engaging in a currency war.  The krone has fallen 18.4% against the dollar and about 3.7% against the euro in the past six months.  It and the Norwegian krona (-18.8%) are the weakest of the major currencies over this period.  Sweden did not need to cut interest rates below zero for its currency to fall sharply.  

 

 

What do all the countries that have adopted negative interest rates have in common?  Not a strong currency, but deflation.  Central banks are fighting deflation with the only weapons it has--the price of money and the balance sheet.  The G20 endorsed countries use of monetary policy.   To call this a war is needlessly alarmist and plays into the hands of protectionists.  The reporters and analysts seem almost to be egging on the conflict the way adolescents might a high school brawl, and to what end?  

 

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Mon, 02/16/2015 - 01:34 | 5789081 JoJoJo
JoJoJo's picture

Hawks and Doves must admit that countries flee to the dollar because it is backed by the baddest super power military in the world. Thats where the buck gets its international gravitas and interest, no matter that its misguided. Foreign countries ate attracted by sword rattling swagger.

Mon, 02/16/2015 - 01:07 | 5789043 Pinche Caballero
Pinche Caballero's picture

Just had a disturbing thought: if the United States goes the way of the former USSR and breaks apart, do each of the twelve regional Federal reserve banks realign themselves as the central bank for each of the newly formed autonomous countries?

I.e., "Growth in the current quarter is tracking around 2.2% according to the Atlanta Fed's GDPNow model."

Look at the most likely ways the break up would occur, and presto! There's already a central bank in each region.

It couldn't be, could it?

Mon, 02/16/2015 - 01:12 | 5789050 Pinche Caballero
Pinche Caballero's picture

The skip up to the front wasn't intentional...

Sun, 02/15/2015 - 21:30 | 5788536 Karl Danneskjold
Karl Danneskjold's picture

Marc:  I cherish your posts, please continue to deliver this great commentary from week to week. 

thank you.

Mon, 02/16/2015 - 02:20 | 5789133 doctorZH
doctorZH's picture

I generally cherish his posts also,  I think this one, however, is ideologically driven.  He wants to hate the Dollar.  He wants the Dollar to be worthless.  Look:QE and ZIRP are anti-dollar.  But QE-America is gone; and every country in the world is ZIRPING.  Many are now neg-ZIRPING.  The EU is now QE-ing.  China is on the verge of devaluing.  Sweden is suddently QE-ing and Neg-ZIRPing.  The strong Dollar is driving foreign money into US stocks.  The only thing can bring more QE into America is a collapse in stocks.  Not likely with foreigners buying US stocks and bonds; and with US corporations still borrowing money for nothing to buy back their shares.  At the moment, US TBonds are the only game in town.  A strong Dollar makes TBonds stronger; a strong Dollar makes foreigner buy more TBonds.

Which currency is going to unseat the Dollar now?  As interest rates go negative all around the globe, you can buy the US Dollar or gold.  If US Interest rates go negative, then only gold will be left.  Will the FED raise short-term rates when the world is heading into more depression?  I dobt it; unless the FED wants an even stronger Dollar.

Yes, there was a pull back in the Dollar last week.  Nothing goes straight up.  Nothing suggests that any trend has changed.  The Euro is heading into existential crisis AND QE.  Is the Euro going to rally?  Canada and Australia are heading into depression with the collapse of oil and commodities -- caused by the strong Dollar.  The only thing that can save oil is more US QE.  And the FED is talking about raising rates, not lowering them, not QE.

Here's the scenario I see: strong Dollar for several years; stronger deflationary pressures globally; default in Asia, India, China.  All the Brics are in trouble.  Strong Dollar refi requires more dollars for billions of dollars of loans taken out in dollars overseas during 5 years of QE.  Weak Dollar inflates; strong Dollar deflates.  The more the strong Dollar deflates the world, the more the world wants US Dollars and US TBonds.  Global defaltion drives rates down, negative.

The US resists negative rates.  The US is the last of the positive interest rates country.  Foeign money continues to flood the US.  If you are a rich Eurpean or Chinese or Japanese busiines would you rather pay you own nation's banks to hold your money or buy US assets and Bonds.  As long as foreigners are buying US assets, no need for more QE.  There comes a breaking point of course; but that is a few years away -- a few years of strong Dollar.

Foreign default brings European banks to their knees, and then US banks also.  Only then does more US QE (weak US Dollar) become possible.  It is likely we will have a world war by then also.

There can be no inflation where there is massive debt.  The debt must be destroyed (through massive default) before inflation is possible (and economic growth).  We should have begun deflatiing our huge debt bubble in 2001.  Instead we decied to build it even larger.  We are still trying to buld in larger -- the Debt Bubble must come down like the Hindenburg.  Until then no runaway inflation will be possible -- once it does, inflation will be rampant, and we will have rates over 30%.

 

For now: buy USDollar; US TBonds; US Stocks; shortsell Oil, Gas, commodities, especially copper and aluminum, coal.

 

What about gold?  Negative for the moment; but it is working on a major trading bottom.  If US interest rates go negative, the last swimmer in the world, then buy gold and wait for the world's greatest gold rally in history.

2019 will be the end of the gold rally.  Short gold 2019-2037.

The main reason the FED wants to raise rates is to protect the US Dolllar against gold.

MJClark, CGTS

Sun, 02/15/2015 - 22:34 | 5788733 Bay of Pigs
Bay of Pigs's picture

Has to be sarc...

Sun, 02/15/2015 - 20:59 | 5788436 Tall Tom
Tall Tom's picture

What is Driving the Dollar?

 

Insanity?

Stupidity?

 

Maybe a measure of both?

Mon, 02/16/2015 - 01:25 | 5789068 Paveway IV
Paveway IV's picture

Neither - in fact, it looked kinda like a cat!

Sun, 02/15/2015 - 19:59 | 5788299 FPearl602
FPearl602's picture

Deflation is Kryptonite for the Central Bank Supermen. Deflation = impaired collateral = loan defaults = bank insolvency.

What is driving the USD is that no country other than the U.S. (and its #1 hitman, the U.K.) have the power to move defaults/deficits into its banks and then off the banks' books into the Fed/BOE. As long as the Fed is around, foreigners know that their money is "safe" because the 2008 GFC couldn't break world confidence in the U.S. greenback, banana republic flows will continue and those "bananas" are basically every other currency on the planet.

And the funny thing is....the U.S. is totally and completely broke, but who the fuck is going to call their note?

Sun, 02/15/2015 - 18:52 | 5788121 Clesthenes
Clesthenes's picture

“There is a high degree of uncertainty in the global markets…  Returning to basics may be helpful in providing ballast.”

Yes, I agree relative to uncertainty; but, “ballast”?  Wouldn’t a realistic cure be more preferable?

The key that provide the lynchpin for this catastrophe that we call global markets is the baseless currency that it is built on.

If that currency is baseless, isn’t everything built on it also baseless?

This should become clear with an understanding of un-anticipated consequence spawned by governments’ attempts to guarantee checking accounts.

By these attempts, the government would seize a failed bank and guarantee all deposits up to, for example, $250,000; amounts over that limit would be lost.

This immediately created major problems for individuals and companies with larger deposits.  A company with a “cash” (checking account) balance of $5,000,000 (add as many zeroes as you like), was suddenly at risk to lose very large amounts of money.

A relative stampede ensued as large depositors sought means to avoid these losses.  A result was so-called zero-balance checking accounts (aka many names).  By this operation, balances would be swept into US Treasuries at the close of business every day.  Then, if the bank failed (was seized) after closing, the company would lose nothing.

Soon, there weren’t enough Treasuries to meet demand.  This led to the huge demand for Mortgage Backed Securities (MBS) as alternatives to US Treasuries.

As a result of these operations, huge amounts of “money” disappeared from the so-called “monetary base”; which, formerly, consisted of paper currency and bank reserves.  Pre-crisis of 2007, this “monetary base” stood at $0.9 trillion, as evidenced by the Federal Reserve balance sheet.  The resulting invention of “cash equivalents” has ballooned to somewhere between $12 and $18 trillion.

So, in the time of some 7-8 years, the “money supply” has ballooned from $0.9 trillion to $15 trillion (approx.).  What Price Gold… will give you more dots to connect.

What do you think lies ahead?  That’s right: a hyper-inflation of the dollar to extinction; and it will take everything with it – on a planet-wide scale.

Sun, 02/15/2015 - 18:48 | 5788106 gmak
gmak's picture

This doesn't say anything about what is driving the dollar. It simply states events that have or are occurring. Where is the value-added?

Sun, 02/15/2015 - 16:21 | 5787679 GreatUncle
GreatUncle's picture

Junk Article.

End of last week Carney BOE is now talking of a period of deflation kind of goes against the upbeat talk of the article.

What is driving the dollar "or was"? FED using QE where a large amount of the liquidity created went to foreign banks. These banks overseas who then lend this so the spending via corporations flows back to wall street.Now seeing as those countries you mention including the UK are going into deflation then the flow of that returning liquidity to the USA will slow.

As for Germany, that monster power house of growth married too France, Italy, Spain, eyc. and not even going to mention Greece. The latter are the ones struggling now and if you were married and your wages were rising but your other half was going the other way. DO YOU CONSIDER IT A JOINT INCOME OR FU DEAR THIS IS MINE AND YOUR PROBLEM IF YOU JOB AIN;T GOOD ENOUGH. Commenting on Germany is naive if the rest are struggling of course GERMANY COULD LEAVE THE EZ ... collapse in full then.

So increased interest rates this year? Doubtful.

If the returning liquidity to the US slows enough ... then the FED will print again it has no choice.

Sun, 02/15/2015 - 16:03 | 5787626 moneybots
moneybots's picture

"What do all the countries that have adopted negative interest rates have in common?  Not a strong currency, but deflation.  Central banks are fighting deflation with the only weapons it has--"

those that cause deflation.  Ironic, huh?

Sun, 02/15/2015 - 15:58 | 5787611 moneybots
moneybots's picture

"Are deflationary forces deepening"

 

Yes.

 

A cycle decline always deepens until it hits the cycle low.  Resistance is futile.

 

 

Sun, 02/15/2015 - 15:12 | 5787458 Mountainview
Mountainview's picture

The currency war obviously.

Sun, 02/15/2015 - 15:04 | 5787437 Consuelo
Consuelo's picture

I think you smell Fear, Professor Chandler.

 

 


 

 


Sun, 02/15/2015 - 14:37 | 5787314 koncaswatch
koncaswatch's picture

 "Are deflationary forces deepening?"  Deflationary forces are the result of capital malinvestment... of course it's deepening.

Sun, 02/15/2015 - 14:26 | 5787300 Thoreau
Thoreau's picture

Cash calls on capital expenditure gas projects - processing - is on shaky ground right now. i'm seeing it. I'm in the middle of it. What with the production/reserve issues, I believe the business is fracked.

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