In this post I want to discuss why the US Dollar will remain buoyed, and likely break out higher, even though the Fed cuts rates.
Also why a stronger dollar exacerbates all the problems in the world.
If you follow my blog ( https://unchartedfx.blog/) and/or social media ( https://www.instagram.com/unchartedfx/) I regularly post stories regarding
macroeconomics and geopolitics. I believe we are heading towards not only an economic crisis (central banks running out of tools, new mandate is
to keep assets propped, and then this mandate will turn into the BUYER of last resort), but also a social and political crisis. More books will be written
about the next few years than any other time in human history.
So why will the US Dollar go higher? And when I mean higher, the break above 98 validates this idea. A break below the 94-95 zone would make me
reconsider my theory.
1)Reserve Currency and Petro Dollar.
It is more about the reserve currency rather than the Petro Dollar, but we should speak about the geopolitical possibilities.
When things in the world start to go crazy, people will run into the US Dollar . This doesn’t mean Gold will fall…it is possible to see BOTH Gold and the US Dollar rise and I argue we will see this. Remember, Gold goes up when confidence is running out in government, banks and policies. It is a confidence crisis asset. With the Fed now beginning a rate cut cycle, it is likely we may go back to QE…which was supposed to be a one time, desperate policy, but many are realizing that this will now be the norm.
However, many still see Gold as this useless, non yielding asset. These people will naturally run into the US Dollar .
America also has the exorbitant privilege for being the reserve currency. Meaning there is always an artificial demand for US Dollars, and the Fed can keep printing as many dollars as they want without caring about debts and deficits…unless Dollar demand takes a hit or the US loses reserve status. The Fed is the of central banks and can bail out others (Canada during 2008 etc).
This is where the Petro dollar comes into play. Currently Iran is the threat because the Iranians take any currency besides the US Dollar for their oil . Countries like Turkey and India love this because their currency priced in US Dollars has gotten decimated. European nations, Japan and South Korea have followed suit, but have reluctantly dropped due to US demands. Turkey and India really cannot afford too.
Russia and China are trying to attack this Dollar demand, and Iran is the key for them. Venezuela is also, but her oil production needs to come back to par, and believe me, Maduro will remain President backed by the Russians and the Chinese solely because he will announce Venezuela will NOT take US Dollars for their oil . This is part of Russia and China’s plan.
In a way, this is why war with Iran is more than likely to happen. It is the way the Americans will protect their US Dollar demand and the role as reserve currency. They will force all nations to use the Dollar for energy. In this way, the US army and other western armies are the armed branch of the .
2)The US looks better than other western nations.
This is thanks to tax cuts implemented by President Trump…and other western nations are being burdened by large tax rates as governments need to tax more in order to spend more. Partly why they want . More taxes in terms of more money through property tax and sales tax etc.
All other western nations will also be cutting interest rates. Australia has already cut twice this year, taking them down to 1.00%. Other nations will also follow along. In this environment, what would you rather hold? Would you still want to hold the Euro or the Canadian Dollar? I don’t think so.
If you factor in that all western nations will be cutting rates, the US still looks the best. Martin Armstrong calls this the “prettiest sister out of the three ugly sisters” situation. That the US Dollar is the prettiest sister out of the three ugly sisters (other western currencies).
3) US Treasury Demand
Now this is the most important reason in my opinion. For fixed income investors, US treasuries still provide the best safe yield for bonds.
Fixed Income products are huge for pension funds. In fact US Social Security is 100% composed of government bonds!
There is about 12 Trillion Dollars worth of negative yielding debt in the world right now! Put yourself in the shoes of a German fixed income manager. Would you buy European or German debt yielding very low, even zero to negative! Or would you rather buy US Treasuries yielding a decent amount compared to other western counterparts?
I have argued in the past that the rise in the US Dollar is because of European money coming over (having to buy the US Dollar in order to purchase US Treasuries or even US stocks). This will continue to increase and it will not just be European fixed income managers doing this. In fact, US Treasuries is the best way for foreign funds to obtain US Dollars.
Very quickly, this is why the Fed MUST cut rates next week, and will likely cut many more times ahead.
1) The bond market. The short end of the yield curve has to be brought down, and the Fed Funds rate yields more than the ten year! Meaning banks
take a negative carry.
2) Real economy is not actually improving, and we are either already in a recession (remember it is a lagging indicator...and PMI coming negative), or
we are heading towards a recession. The Fed wants to act quickly.
3) To help service US government debt as well as the consumers. So much bad debt out there, and the consumer needs to borrow more to live.
4) The Fed has to relieve the pressure mostly from emerging markets. EM dollar denominated debt gets more expensive as the dollar gets stronger,
which leads to more problems, and also plays a factor for those nations to buy oil from Iran bypassing the US Dollar .
5) Also Jerome Powell and the Fed have talked themselves into a corner. Stock markets only care about cheap money. This is why they are up. When
rates go down, the stock market will be the only place to go for yield. The Fed now needs to deliver...a 25 basis point cut may not be enough.
So the Fed will be cutting but rate cuts will not prevent the Dollar from rising. This means the Fed may have to "kill" the dollar to save the world.
We are likely to see some new type of Bretton-Woods type conference to sort this all out.
By the way: If I was a Russian or Chinese strategist, I would be telling dark pools and offshore funds to buy the dollar. Keep it propped up even with
bad data and rate cuts. This way more nations will be pressured to drop the Dollar to buy Iranian Oil (ally of Russia and China and key to their geopolitical ambitions). Even Saudi Arabia and other gulf states may drop the dollar just to ensure they do not lose their market share (and the Russians would guarantee the Saudi's military protection). Not to mention the pressure it would put on the Fed and America.
How can the Russians and Chinese do this because the dollar going up means the Ruble and Yuan would be going down you ask? Gold .
Gold priced in Rubles and Yuan will go up and both Russia and China own large reserves and continue to buy more.
This is how Russia survived US sanctions. Even though the Ruble got decimated, Gold priced in Rubles went up allowing the Russian to operate with not much damage.
Gold is also a way for these Eastern nations to bypass the Dollar. Gold will be used to settle payments. You sell Oil to China, but don't want to hold Yuan reserves? China converts the Yuan to Gold , you take the Gold , then convert it back to your currency. No US Dollar involved.