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The dollar has been in a general downtrend for over a year, but Marc Chandler of Brown Brothers Harriman doesn't believe this trend will continue for much longer. If a turn in the dollar does indeed take place, this will have a number of implications for investors and specific asset classes, particularly commodities.
Bullishness on Dollar Remains Intact
Chandler is still bullish on the dollar for two key reasons.
First, we have to consider the Fed’s interest rate policies. Over time, wider interest rate differentials will make it painful to be short the US dollar, Chandler stated.
Also, from a technical perspective, if we look at the big dollar rally beginning in 2014 that lasted until early last year, we have to ask how far we came off that rally, and whether it was enough to change the trend.
“We came close to those levels that would have indicated we were changing trend for the dollar, but it stopped,” Chandler said. “The key level I would point out here would be 126 to 127 in the euro. We stopped at about 125.50, and now we’re trading a little bit below 122.”
Capital Flows
The US is ahead of other countries with five hikes currently behind us, Chandler stated, and a lot of economic data suggests we’re in the late part of the business cycle. Europe, in contrast, seems to be in an earlier stage.
As a result, we’ve seen capital flow into European equities, and the ECB is still buying bonds, giving investors another tailwind.
Ultimately, Chandler sees the synchronized global recovery as last year’s story. Many seem to have decided that European stocks aren’t as overvalued as US stocks, and that they prefer emerging market equities, which presumably offer a bigger bang for their buck, despite the Fed raising interest rates.
This capital flow trend may have limited the dollars at play in the rally. But the even larger issue is, Japan and the Eurozone have large current account surpluses. They are selling to the world more than they’re buying and accumulating savings.
“If they don’t buy foreign assets with those savings, their currencies go up,” Chandler said. “The US has a large trade deficit. … We’ve got a worsening trade balance, and the US needs to import capital. When it doesn’t import the capital, the dollar sells off. The US is not importing enough capital yet, and at a higher interest rate, I think it will.”
Three Hikes or Four?
With the new Fed chairman coming in, markets seem to have taken his recent statements to indicate the Fed is turning even more hawkish. Right now, the market is only pricing in three rate hikes, but Chandler didn’t hear anything from Powell to make him believe four hikes are coming this year.
We have to remember we’re likely late in the cycle. For example, the 12-month moving average of non-farm payrolls peaked 2 years ago in 2015. The 12-month moving average of auto sales seems to be rolling over, and credit card delinquencies are headed up, which is also characteristic of the late cycle.
“I think this (behavior) is a combination of the late cycle and people putting too much credence into the fiscal stimulus,” he said. “I want to see the economy prove itself, so I’m still leaning toward three hikes.”
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