We like the dollar story presented by Alan Ruskin of RBS. This dollar smile seems to make sense in the current uncertain environment. His argument is simple. The dollar will fall into one of four categories. The extremes will lead to dollar rallies and the moderate periods will be dollar negative.
In the first case, a crisis, we will see the dollar rally under flight to safety behavior. This behavior is what we saw last Fall with the strong dollar rally. The market wanted to avoid risk taking so money came to the dollar and dollar deleveraging increased.
At the other extreme will be a strong V-shaped recovery which will also see a strong dollar rally. Under this case, there will be stronger than expected growth, the US deficit will be closed, and the risks of quantitative easing will be diminished. While this may be a low probability event, it would be dollar positive. Money will flow to the dollar because of better investment opportunities.
The two most likely scenarios would be a tepid U-shaped recovery or a slow growth environment. Under the tepid case, there may be increased demand for risky assets in other countries. This may be a good emerging market environment. The other case o slow growth would be a normal recovery where growth fits within what has been expected by the consensus. who is thinking that we will be on a lower growth path. This certainly would not be a V-shaped recovery but a controlled growth. Under this scenario, there would be a desire to find risky assets outside of the US.
A problem with these scenarios is the underlying assumption that there is a decoupling between the US and the rest of the world. We have not seen this over the last few decades. The rest of the world will be able to move ahead without the US and the investors will looking to other parts of the world for the best returns opportunities. Given this world view, the dollar will diminish in importance. While we are not counting the dollar out, the dollar downside is greater if we have a economic muddle.
In the first case, a crisis, we will see the dollar rally under flight to safety behavior. This behavior is what we saw last Fall with the strong dollar rally. The market wanted to avoid risk taking so money came to the dollar and dollar deleveraging increased.
At the other extreme will be a strong V-shaped recovery which will also see a strong dollar rally. Under this case, there will be stronger than expected growth, the US deficit will be closed, and the risks of quantitative easing will be diminished. While this may be a low probability event, it would be dollar positive. Money will flow to the dollar because of better investment opportunities.
The two most likely scenarios would be a tepid U-shaped recovery or a slow growth environment. Under the tepid case, there may be increased demand for risky assets in other countries. This may be a good emerging market environment. The other case o slow growth would be a normal recovery where growth fits within what has been expected by the consensus. who is thinking that we will be on a lower growth path. This certainly would not be a V-shaped recovery but a controlled growth. Under this scenario, there would be a desire to find risky assets outside of the US.
A problem with these scenarios is the underlying assumption that there is a decoupling between the US and the rest of the world. We have not seen this over the last few decades. The rest of the world will be able to move ahead without the US and the investors will looking to other parts of the world for the best returns opportunities. Given this world view, the dollar will diminish in importance. While we are not counting the dollar out, the dollar downside is greater if we have a economic muddle.
1 comment:
I'm a Dollar Bear. In my opinion, there are just too many forces acting against a strong USD. We've recently seen growth from France and Germany, and now Canada. While the US GDP is expected to grow at 3.5% annually in the 3Q, based on one estimate I read, we are growing subsequent to many other large developed economies have. The consumer is not spending, and ex-auto sales nothing is really moving.
I think the strength in Europe (ex-Ireland and Eastern Europe) is a boost for the Euro and Sterling vs the USD. On the other side of the world, Japan, while dependant on exports, is also improving, while China and emerging Asia is pumping along very nicely. Even India with is poor monsoon season is growing very nicely. As currency investing is a relative play, I see too much strength outside the US to think the USD will appreciate relative to these currencies.
Throw on the massive budget deficits, not only at the federal but state and municipal levels, and that puts downward pressure on the Dollar as default risk increases. With a steep yield curve, and my expectation of a high level of inflation, I fear for the USD.
I have been and remain bullish on the global economy, but prefer, like in your U-shaped recovery scenario, to seek my risky assets outside the US.
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