TD Securities with the note. I don’t agree with them. DXY is not going to fall as the US recession gathers steam. That promotes the flight to safety. Moreover, it presents China and Europe as the victims of a follow-on trade shock that will drag them down shortly afterward. Indeed, I am still quite concerned that the entire Fed tightening cycle ends in a China crisis that crashes the CNY.
In short, DXY is king at least until the Fed flips and perhaps until US growth bottoms.
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The year’s first half has seen a notable shift in market themes, drivers, and correlations. The early focus of the relative macro divergence theme has morphed into a single risk correlation trade. The USD sits at the center point of this environment, reflecting its role as a global risk hedge. The uncertainty over the impact of excessive monetary tightening, China’s growth outlook, and the broader implications of the Russia/Ukraine conflict on Europe have added to the USD’s stagflation hedge appeal.
•We continue to expect a resilient USD through the early parts of the summer, reflecting the lingering uncertainty of these drivers. Our G10 FX forecasts are currently under review. That said, the following months and quarters present increasing downside USD risks, especially as we see correlations and themes changing once again. Excessive Fed tightening could start to turn on the USD, especially as US equities and growth continue to come under pressure.
•The USD currently trades at a big premium to rate differentials, suggesting much of the Fed news is priced into the USD. The USD also trades at a premium to risk, global growth expectations, and a China market-based factor. The global nature of inflation also means that others will likely start to converge with the Fed. This comes at a time when the US broad balance of payments has deteriorated sharply, with the US current account deficit at 3.5% of GDP.
•On the global side, we note that US growth expectations have fallen faster than most, while US equity markets, especially the Nasdaq, have significantly underperformed recently. Ditto for US data surprises. Meanwhile, China’seconomy is gradually reopening, and fiscal policy remains accommodative in the Eurozone.
•Consensus expectations have both China and the Eurozone outgrowing the US at the end of next year. That’s important in the context of the US’s rising current account deficit (and deteriorating broad balance of payments), as the overvaluedUSD has relied on the kindness of strangers to keep the party going. A mix of aggressive Fed tightening and underperforming US assets could reduce the USD’s appeal, especially if some of these other global growth risks start to ebb in months ahead.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
