Goldman's Tom Stolper Conducts Sunday Hitfest On The USD

It is one thing for Tom Stolper to release precious tidbits about what is not going to happen in the future on a weekday - for those we are very grateful. But doing so on god's (or is that Goldman's) day is truly a first. In a note just blasted out, it would appear there is no rest for the Stolper, and according to the world's most admired FX strategist (remember: batting 0.000 is just as useful as batting 1.000), "Dollar downside forces on the rise" and that Goldman is positioned "short the USD again"... Just as Goldman was positioned long the Russell 2000 literally the minute the market topped on Thursday (no joke - check it). And to think it was only three weeks ago that the same strategist saw downside risks for the EURUSD to 1.20...

Goldman Sachs at its goalseeking best:

Dollar Downside Forces on the Rise

1. We are Positioned Short the USD Again. The Dollar is likely to embark on a round of broad weakening. The underlying BBoP situation has not improved at all, suggesting that the trend decline remains intact, as we highlighted in the last FX Monthly. But over the last couple of months, the increase in broad risk aversion has helped the trade weighted Dollar to a 6% rally, broadly following the pattern of what we have seen in 2008 and 2010. In both cases, the subsequent relaxation in risk aversion led to a substantial move lower in the Dollar, which then reasserted the underlying down trend. Earlier this week, following the Fed meeting, we initiated fresh short Dollar positions against the EUR, CAD and MXN on the back of this view.

2. Many Risks Remain but Skew has Changed. The key point is that we think much of the bad scenarios have been priced by the market and that there is more scope to surprise on the upside from here. That does not mean that downside risks have all gone. We and our European economists remain concerned about a derailing Greek PSI negotiation, contagion to Portugal or the impact on Eurozone growth from continued fiscal tightening. The upcoming elections in France could create policy uncertainty as well. But our worries are widely shared already and hence likely reflected in market prices. Against that, cyclical indicators continue to improve in all regions, even in Europe now. And on some of the most threatening policy issues in the Eurozone signs of tentative progress can be identified, for example in relatively smooth ESM and Fiscal Compact negotiations. From a tactical point therefore, the scope for further escalating risk aversion may be smaller than the relaxation of already rich risk premia. This would imply more downside risk for the Dollar and less downside risk for the EUR than before. A spike down to 1.20, as we had signaled earlier as an important near-term risk, now appears much less likely.

3. Why We Like the CAD and MXN. US activity has surprised more notably relative to expectations than any other region so far. This has already led to some market repricing in growth sensitive assets. Our current long recommendation the Russell 2000 initiated by Noah Weisberger and team, as well as the current short UST recommendation by Francesco Garzarelli and team follow this logic. If a broader USD decline now follows on the back of further declining risk premia, North American currencies should be the obvious beneficiaries. On one hand they should benefit from better external demand from the US, and on the other, they will benefit form broader USD weakness. In addition, the Mexican central bank has maintained a relatively hawkish stance, as Alberto Ramos points out. In Canada, the BBoP remains very favourable and in both currencies substantial speculative short positions suggests ample room to rally in case of broader USD weakness, as Robin Brooks has highlighted in his regular IMM reports.

4. Better US Growth Won’t Help the USD. As discussed in the previous section, we believe that better US growth rather acts as a USD negative factor because of the dominance of risk correlations. In fact, these risk correlations have become even stronger since repeated intervention in the JPY and CHF has reduced the attractiveness of these traditional safe have alternatives. Moreover, even when we try to nail down empirically how US growth correlates to the Dollar, the overwhelming result is that there simply it is neither strong nor persistent. Fiona Lake looked at this in some detail in a recent daily and only finds some evidence pointing towards a negative relationship in recent times - consistent with the dominating risk correlation mentioned before. Two important points in that respect: Large and mature economies with deep asset pools invested globally may react differently to growth shocks than small open economies. In the former group, a positive growth shock may predominantly trigger a search for riskier investments abroad and hence currency weakness. To the contrary, in a small economy a positive growth shock may trigger capital inflows from foreign investors and hence appreciation. As our regular analysis of the TIC data highlights, better US growth numbers in recent years have consistently failed to improve capital inflows into the US. 

5. Cross Atlantic Monetary Policy Differentials and Risk Premia. FX markets continue to face the challenge of having to compare very different non-conventional policies across the globe. Are two ECB LTROs a more dovish signal than the new Fed commitment to keep rates at exceptionally low levels until late 2014? We don’t really know. But we would make the following observations. First, the ECB policy easing via rate cuts and the first LTRO has already been reflected in rate and FX markets. Eonia has already dropped back to the lows seen during the Global Financial Crisis. On a relative basis, the dovish Fed surprise is more recent and – maybe – not fully be priced yet in FX markets. Second, the ECB LTRO not only affects the FX markets via a straight interest rate correlation but also via reduced funding stress. As a back stop to the financial sector, the LTRO has therefore reduced the likelihood of tail risk events. This in turn may help a gradual further relaxation of Eurozone fiscal risk premia and more EUR/$ upside from current levels. Similarly, the dovish Fed surprise will likely affect the Dollar negatively via broader risk sentiment in addition to the more direct rate channel. In the last FX Monthly and even more so in a Global Markets Daily this week by Robin Brooks, we have tried to quantify a risk premium reduction via several different approaches and they all point towards 1.40 and above.

6. Global Imbalances Remain Pronounced. With all the focus on the Dollar and European risk scenarios, it is important to not forget the bigger picture of global FX markets. In the latest Global Economics Weekly, Themos Fiotakis has updated our work on global imbalances and found further evidence that not much has changed since the global financial crisis. Imbalances remain large, highly dependent on demand differences and remarkably insensitive to FX moves. This suggests currency markets have scope – and in fact need – to move very substantially in order to help reduce imbalances. The current 9% trade weighted undervaluation of the USD is likely not big enough, therefore, to help induce a declining US current account deficit and global rebalancing. Looking at valuation signals in this context suggests that some countries with external vulnerabilities will ultimately see further currency weakness – or at least substantial underperformance. TRY, INR or HUF spring to mind on this context.

7. “Wall of Money” Implications for Reserve Currencies. Finally, to add to the USD negative tone, there is evidence of re-accelerating capital inflows into EM. We have discussed this dynamic extensively in the last 18 months under the title the “Wall of Money”. One very interesting aspect of this dynamic, discussed by Themos Fiotakis and Robin Brooks in another Global Markets Daily, is the implication of funding. For many Asian surplus currencies the natural anchor currency is the Dollar, and with the Fed arguably being one of the most dovish central banks in the world, “Wall of Money” flows have a high likelihood of being predominantly funded out of USD. To prevent appreciation of their local currencies, Asian central banks then accumulate these Dollars in their FX reserves, and subsequently diversify the Dollars into other liquid reserve currencies. In other words, the combination of “wall of money” flows, a dovish fed, systematic reserve accumulation and diversification boils down to one big leveraged global USD short trade. Of course during period of risk aversion this dynamic goes into reverse. However, as we explained above, the skew in the key risk scenario has changed, which suggests the USD negative dynamics will prevail for now.


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