We published a bearish view on the US Dollar today on Seeking Alpha. Below are some excerpts:
- The bullish dollar argument rests on the idea of a chronic shortage in the offshore eurodollar market as demand for dollars for loan and debt repayments surges.
- Our take is that the apparent shortage of dollars reflects the temporary hoarding behavior of dollar holders which should be eased by the Fed’s liquidity provisions.
- The Fed’s commitment of unlimited QE and the Treasury’s huge deficits are likely to overwhelm near-term dollar shortages and create long-term depreciatory pressures.
- This should see the dollar index decline in line with the trends seen inreal yield spreads between the U.S. and its peers.
“The bullish dollar argument rests on the need for this huge level of debt to be serviced. Non-U.S. banks loaned the money into existence but the interest required on the loans has to come from elsewhere. With dollar availability from new loan creation grinding to a halt, this creates a very inelastic demand for U.S. dollars as businesses need the dollars immediately to prevent default. Furthermore, the stronger the dollar goes, the more in demand it becomes as the level of indebtedness rises for businesses operating in depreciating local currencies.”
“To call this a dollar shortage seems like a mischaracterization. While there is indeed a shortage of dollars for those who are heavily indebted, this merely reflects the lack of willingness of on the part of lenders to lend. The dollars exist, they are just being hoarded by savers who are not willing to lend them out.”
“The Fed’s response to recent dollar appreciation and market turmoil has been very aggressive. As well as re-opening swap lines to address short-term liquidity conditions it has promised unlimited QE. The Fed is aware that the dollar strength and the associated tightness in credit markets could trigger a debt-deflation spiral in the U.S. economy and is pro-actively making sure this does not happen. For the Fed, creating more dollars is a matter of life and death. If they fail to print enough money to prevent dollar strength and equity weakness, they will likely be replaced by people who will.”
“The U.S.’s net external liabilities have more than doubled over the past decade and now sit at roughly 50% of GDP. If the U.S. dollar was not the world’s reserve currency dollar holders would have likely shifted their assets to a less indebted country before now.”
“The DXY has typically followed the path of the spread of real interest rates between the U.S. and its constituent currencies. The extent to which the DXY has historically veered away from real yield spreads has reflected net speculative positioning on the dollar versus the majors. As the chart below shows, the dollar is currently a record distance above where its traditional drivers would suggest is fair value. As the liquidity crisis continues to be eased by a proactive and resolute Fed, the fundamental drivers – particularly real interest rates – should driver the dollar weaker.”
