U.S. Dollar = Putting In A Top? – ValueWalk Premium
U.S. Dollar

U.S. Dollar = Putting In A Top?

Headline: Dollar Traders Overly Focused On Central Bank Policy Differentials.

Q4 2021 hedge fund letters, conferences and more

U.S. Dollar

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The Above Weekly Chart Of The US Dollar Does Not Not Appear To Be Particularly Excessive.

A Nice Advance Off Of The May ’21 Lows & The Bullish Trend Seems Well Entrenched…And There Are Many Valid Reasons For That:

  1. Inflation Is Running “Hot” In The U.S.
    2. The Federal Reserve Has Pivoted Toward Reducing Balance Sheet Liquidity…For At Least…The Next 12 Months…Well In Advance Of The ECB.
    3. U.S. Interest Rates…On A Relative Basis…Currently Offer Attractive Yields To Global Investors i.e. 10 Year Bunds In Germany Are STILL Negative Yielding.
    4. Foreign Sovereigns Welcome A Strong Dollar…Supporting Export Growth.

Seems Like A Slam Dunk “Long” Position…But You Might Want To Think Again.

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First Of All…Points 1-4 Above Are Very Well Understood…And Potentially Already Discounted In The Dollar’s Current Value.

Secondly…Inflation Is Running “Hot” Globally…Not Just In The U.S…Which Will Eventually Force Most Central Banker’s To Tighten Their Loose Policy Grips.

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And With Headline Inflation… Currently In Excess Of 7%…Interest Rates Are Substantially Below Where They Ought To Be.

Historically…Short Term Sovereign Fixed Income Yields Approximate …And Typically Exceed…The Rate Of Inflation.

But For Now…The Federal Funds Rate In The U.S. = ZERO…Country Miles From 7%…Of Which…Central Bankers Are Well Aware.

So Why Not Forcefully Act To Raise Interest Rates…Pronto…In Order To Quickly Defeat The Acute Inflationary Impulse?

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Primarily Because Of The Negative Price Impact To Global Assets… Especially Equities.

Future Cash Flow Discounting Mechanisms Are Slowly Gaining Traction…After Years Of No Discounting…Due To ZIRP…

And The Price Action Of Many Extremely Over Valued Equities …Bereft Of FCF…Are Already Treacherously Negative.

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Importantly Too…The Impact On Sovereign + Private Debt…Could Also Be Especially Sharp…As…

Fundamentally…Sovereign Bonds Are Significantly Over-Valued

Considering Bond Prices Have…Generally…Been In A Bull Market Since The ’80’s…And Squeezed Especially Higher…Over The Past Decade…By Central Banks’ Price Insensitive QE Policies [as demonstarted in the below chart]…

U.S. Dollar

Thereby Creating Excess Demand For Alternative Fixed Income Securities…Compressing Any Rational Risk Premium…Which Therefore Translates Into Their Own Dramatic Over-Valuation.

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Moreover…Rock Bottom Interest Rates Have Swelled Sovereign Debt Issuance Into The Stratosphere.

And This Tidal Wave Of Supply…In A “Hot” Inflation Market…Likely Results In Further Problems.

For Instance…Despite Short Term Interest Rates Being Suppressed At Zero For Over A Decade…Interest Payments On Debt At The U.S. Treasury Are At Record Highs…Almost $500B/Year…Just Below The Annual Medicare Spend.

Amazingly…This Data Point Is Suppressed…As The Interest Payments On The Fixed Income Securities…Held At The Federal Reserve [30% of National Debt]…Are Rebated To The U.S. Treasury…For Now…

Thereby Reducing The Actual “Hard Dollar” Interest Costs To The Federal Government.

Thus…The Current $500B Interest Expense Line Item In The Treasury Statement…Catapults Much Higher In A Tightening Monetary Environment…

For 2 Primary Reasons:

  1. Absolute Interest Payments Naturally Increase In A Rising Interest Rate Environment…As Debt Is Refinanced.
    2. As The Federal Reserve Contracts It’s Balance Sheet The Aforementioned Rebates Back To The U.S. Treasury…Naturally Reduce.

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So…It Is Almost Certain That Interest Costs On U.S. Sovereign Debt…At The Very Least…Become A Top 4-5 Federal Budget Item In The Not Too Distant Future…

Quickly Approaching The $750B Federal Defense Budget.

And Since…On A 12 Month Rolling Basis…The U.S. Has Produced Uninterrupted Fiscal Operating Deficits Since 2001…

National Debt Endlessly Grows…And Critically…Well Beyond GDP Growth Too.

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So Then…Given All…What Price Direction For The US Dollar?

Typically…Serial Budget Deficits Combined With Mountains Of Ever Accumulating National Debt Are Not Currency Supportive.

But Many Of The Developed + Emerging Economies Balance Sheets + Treasury Statements Are Similarly Positioned.

Therefore…On A Relative Basis…This Concern Is Neutralized.

Plus The US Dollar Is Still…UNDENIABLY…The World’s Reserve Currency…And That Is Not Changing Anytime Soon…Regardless Of The Protestations From The “Crypto Currency Crowd.”

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Even So…The U.S. Dollar Is Vulnerable…

Despite Dollar Liquidity Almost Certainly Being Reduced In The Forthcoming Year…For The Following 5 Reasons:

  1. U.S. Monetary Stimulus Is Cresting…Leading To…
  2. U.S. Economic Growth Peaking.
  3. U.S. Economy Peaking = Deficits + Debt Will Bulge Higher.
  4. Foreign Central Banks Will Eventually Mirror Federal Reserve Tightening Policy.
  5. Bullish Dollar Sentiment Overly Focused On Current Central Bank Policy Differential = Too Excessive + Obvious…Presuming Economic Status Quo Persists.

Article by Global Slant


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