FYI | Sep 15 2008
(This story was first published on Wednesday, September 10, but only accessible to paying subscribers at the time. It is now being made accessible to all readers.)
It was Alan Greenspan who once suggested that if someone wanted to forecast future movements of a given currency, that person might as well just flip a coin. While this may well be true, in a general sense and at different times, this time around I beg to differ.
Taking a longer term view on currencies has been rather easy over the past two decades. Throughout the nineties the US dollar was in a strong bull market fuelled, among other things, by a leading role for US technology companies and financial institutions, and supported by a booming and leading US economy. Never, in the history of the world, has one single economy been as dominant as the US was at the end of the nineties.
Since the turn of the millennium things have reversed. The US economy is still the world’s largest but arguably no longer leading the rest of the pack, its financial sector is in disarray with once mighty institutions now fighting for survival. And the US dollar? The greenback is now firmly in a long term bear trend.
I am not telling any secrets thus far. Any chart with historical data over the past two decades will confirm all of the above.
As such, deciding on a longer term view on currencies has been easy, very easy. At least, as long as we’re talking any currency vis-a-vis the US dollar.
This is exactly why the current changes in financial markets are as rapid, as fierce and as relentless as what we’ve seen over the past two months. Taking a longer term view on the direction of the US dollar had been so easy that when time came for the greenback to reverse its trend, nearly everyone, from small to big, from novice to experienced, from hedge funds to long only funds was instantly wrong footed.
It is the scramble to re-align portfolios and market positions back into line with today’s reality that has been causing mayhem in currency markets, commodity markets and emerging equity markets. But that’s only part of the story.
The most important factor behind the sudden strength for the US dollar is because economic growth outside the US is slowing, and it is doing so at a rapid pace. The US might be the main culprit behind most of the problems we’re dealing with at the moment, but it is economies in Europe, Japan and elsewhere that look like heading for a true blue recession. The US economy has taken it on the chin, but its resilience thus far has brought about a widespread sense that worst case scenarios might just be avoided.
It is this cocktail of negative economic developments that is currently behind the rise and rise of the US dollar. This is why I have a strong feeling this change in fortune is far from over for the greenback. I think all those who are calling for a pause and resumption of the previous trend (as they have continued doing so since the greenback started its revival now two months ago) are going to be surprised by how long and how far the greenback might strengthen.
The US dollar has now become the universal barometer for global economic growth. But in reverse.
This is why I believe investors should pay close attention to the direction of the US dollar in the weeks and months ahead. If the greenback strengthens further this means investors continue to take ever gloomier views on economic growth outside the US. We already know the US economy is in a far from healthy state, thus expectations for worse developments elsewhere don’t make for a pretty picture (and that’s probably an understatement).
That’s why I hope I am wrong in my prediction of a continuously strenghtening US dollar. I very much hope I am very much wrong.
This explains why a strengthening US dollar is a major negative development for commodities. It is not about commodities standardly being priced in US dollars, and thus a stronger currency reduces demand across the globe. This is about the reason behind the rise of the greenback, which I assume all of you agree is far more important.
I can definitely see plenty of opportunities for economies in Europe, Japan, and even China to generate plenty of negative surprises in the months ahead. Hence my suspicion the current US dollar revival still has plenty of ground to cover still.
Last time the US dollar reversed course, in the closing quarter of 2005, the surge lasted for six months, which could possibly take the current recovery into 2009, just like it lasted into the next year back then as well. Some experts have been very hopeful in suggesting that prices for commodities, and thus for shares in miners and mining developers, are poised to recover from October-November onwards.
I’d say don’t take such scenarios for granted just yet. Watch what the US dollar is doing first.
With these thoughts I leave you all. Till next week!
Your editor,
Rudi Filapek-Vandyck
(as always firmly supported by Andrew, Greg, Joyce, Grahame, Chris, George, Todd and Pat)
