Willingness to sell the dollar, but a rout never materializes

Outlook

: We continue to smell a willingness to sell the dollar, but a rout never materializes. Yesterday Bloomberg reported that the FX strategy guy at HSBC thinks we are wrong to go down that path. “Everyone’s convinced themselves the dollar’s going to be weaker. It’s the third year in a row they’re going to fail. They got egg on their face last year, they got egg on their face the year before and now they’re going for the triple egg.”

The reason is yield advantage, full stop. The US 2-year is 1.56% vs. negative or lesser returns everywhere in the developed world (and some in the EM world). Sterling is the exception, and now that the political risk of a no-deal Brexit is gone, it should become a buy. If you don’t like the dollar hotel, there’s another one across the road—sterling. Emerging markets may have had their day, too. As they lower rates, at some point classic EM risk kicks in. Are you listening, Bank of Mexico?

HSBC has a point but it’s also true that the correlation between the dollar and yield differential breaks down sometimes. We can have long periods when other issues dominate, usually the twin deficits (trade and budget). For a while the US had to deliver about 2.5% more than others to hang on to a rising trend in the dollar. Today the US-Bund diff is 2.035%, for what that observation is worth. Sometimes the differential doesn’t matter at all, as during Grexit and for sterling, during the first year of Brexit. Grexit is what brought risk-off to the top of the factor list, reappearing in top hat when Trump started the trade wars. The implication is that if the US voters throws the bum out next November, the dollar will fall on that factor alone—a drop in risk aversion—regardless of relative interest rates.

So, the ruling nature of yield differentials is true generally but not always useful under specific conditions. If the eurozone economy were to recover sharply, for example, and the ECB were to respond with even a small rate hike, the euro could rally even as the US retains a yield advantage. The trajectory of returns counts, too. If Europe is going up and the US is going down, the advantage matters a whole lot less. Traders take positions on anticipation of upcoming events, not just current conditions.

Today we get Dec US  housing starts, expected higher and industrial production, expected unchanged or perhaps lower. The University of Michigan consumer sentiment index is also expected unchanged. More interesting will be JOLTS and various earnings reports. Almost unnoticed is two more Fed board members, including the awful Judy Shelton. Delaying the approval process while bigger things came along was good tactic to diminish opposition to this fruitcake. Her book, Money Meltdown, will give you indigestion for a month. She thinks the Fed should be abolished and the dollar re-linked to gold. The other nominee, Christopher Waller, was head of research at the St. Louis Fed and a hero for staying in the same room with Shelton.

It looks like the dollar has plenty of miles to go.

Tidbit: The FT reports Chancellor Merkel said Brexit is a “wake-up call” for Europe, which should become more innovative and welcoming to research and education. It should also create a banking union and “digital single market,” whatever that means, and start taking a lead in tech. We like Merkel and think she has been a valuable and stabilizing figure, but these are pipedreams. Plenty of European countries have tech and computing skills, as well as an educated workforce. In fact, the European workforce is far superior to the American one. Literacy is near 100% vs. 79% in the US (and that’s generous). Drug addiction is far less. Crime is far less, too. 

What they don’t have is venture capital, the entrepreneurial spirit (remember when all those French inventors moved to Britain), and a risk-taking mentality. Remember the Neuer Markt? It was supposed to be the German Nasdaq, but crashed and burned after only five years.

We don’t blame “socialism,” although plenty of Americans do. We imagine it’s a cultural development. A society that delivers guys in garages has a history of guys in garages. We even have a TV show about inventors/innovators and whether they deserve funding.

Some of the US lead is tolerating non-conformists, too, and another part comes from a less rigid treatment of labor and a whole lot less independent contractor/small business regulation. Want to be a house painter or make jewelry? You can’t just set up shop in Europe—you need capital, a license, a buying community open to a newcomer and maybe an apprenticeship. US educators keep saying we need an apprentice system like the one in Germany, but that is really an extension of the medieval guild system and can be just as much of a straitjacket. It’s government-sanctioned organizations interfering with supply and demand, and that always results in a misallocation of resources. In the US, we may have too little or too much government interference here and there, but Europe definitely has too much everywhere. Finland gave us Nokia—and then lost the lead to the US, which has sustained it.

Where Merkel can shine is the €40 billion initiative to wean Germany off coal. This serves multiple purposes, including a jab at Trump but more importantly, putting Germany back on track to meet international standards and take away a big part of the platform of the Greens, who have been steadily gaining voters over the years, according to The Economist. It’s a fine legacy on many fronts.

Tidbit 2: In US politics, the state of Virginia is under the thunderhead of a potential neo-Nazi/white supremacist attack next Monday, with several serious trouble-makers already arrested, a gun ban for the capital (about 35 minutes from our house), and a contentious debate over proposed gun legislation.

In Washington, the shocking disclosures by Rudy’s henchman Parnas are starting to be investigated. We can’t accept the word of a sleazy criminal, but after all, Trump’s sleazy lawyer Cohen ended up proving his case that Trump masterminded the crime. As for some Republicans claiming all the House testimony was second-hand and started from the whistleblower’s second-hand information, the evidence backing up the articles of impeachment and delivered to the Senate include the testimony of Ambassador Sondland, who said he was working with Trump's attorney Rudy Giuliani on Ukraine matters at the "express direction of the President of the United States." Yes, there was a quid pro quo (military aid and White House visit in exchange for the announcement of a Ukrainian investigation of Biden) and “everyone was in the loop” including Pence, Pompeo and Mulvaney. Still, a sleazy criminal confirming an amateur political appointee is not enough. We need more confirmation. The key question for next week’s Senate proceedings is whether we get it.

Yesterday the Government Accountability Office announced that Trump withholding aid from Ukraine was indeed a crime as a violation of the Impoundment Control Act (1974), as many career civil servants in the Office of Management and Budget, Dept of Defense and State Dept had worried at the time (and were overridden by Trump-appointed political hacks). The Republicans who keep saying “not a crime, doesn’t rise to the level of impeachment” will not eat their words, but should. Now they will try to keep out this “new evidence” along with the Parnas charges as not having formed part of the evidence transmitted with the articles of impeachment. Now that’s sleazy, too. House Speaker Pelosi held back the articles for several weeks ostensibly to get the Senate to announce its rules, but in reality so that the public could express its view that a trial always has witnesses and documents, and so that new evidence could come out. And so it happened.

Now we await news on who is going to subpoena Bolton, who is expected to know everything about the “drug deal”—unless executive privilege intervenes. Trump will be acquitted, but will also be revealed as a sleazeball who acts only on self-interest and never on the interests of the state. The problem is that he has no sense of shame. 

 

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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