With its back up against a wall, the US Federal Reserve has pledged to begin tapering its asset purchase program. Beginning later this month, the Federal Reserve will taper the number of US Treasury Securities it purchases each month by US $10 billion and the number of Mortgage-Backed Securities by US $5 billion.
By all accounts, a dreaded ‘taper tantrum’ has been avoided in the wake of the announcement. At least in relation to the forex market. Federal Reserve chairman Jerome Powell has been extremely careful to prime investors for this moment. For one, all hawkish commentary from the chairman has been mediated with dovish caveats. Admittedly, less senior Federal Reserve officials have done much of the leg work in hinting and out-right suggesting the need for a reduction in its purchases. Either way, the conversation surrounding tapering has been sustained for months, giving investors time to mull over the implications.
As of writing, the USD index, the DXY has crossed back over the 94.00 mark and comfortable sits 94.33, up 0.53% since the Federal Reserve’s tapering announcement.
The Federal Reserve will still be purchasing $105 billion worth of securities, with further reductions dependent on continuing favourable economic outlook. The Federal Reserve has indicated it is considering reducing spending, month over month, moving forward. However, if economic conditions deteriorate, the spending reductions could be nullified or reversed. The Federal Reserve will be keeping an eye on inflation and the number of jobs added to the economy each month.
A significant consideration of the Federal Reserve when determining its reduction in spending is the US inflation rate. While it is at a 13-year high, the Federal Reserve maintains that most of the inflation experienced heretofore is temporary.
Octobers inflation number is released next Wednesday. Trading Economics is forecasting a 0.1% increase in US inflation.
Another significant consideration of the Federal Reserve when determining its tapering is the Non-Farm Payroll (NFP). The NFP indicates how many non-farm jobs were added to the economy in a given month. The data for the October non-farm payroll will be released tonight to great anticipation. Trading Economics is forecasting 400K jobs, while the market consensus is a little more optimistic and is forecasting 450K jobs.
The NFP has disappointed for the past two months, with actual job figures falling far short of the numbers predicted. Even so, the Federal Reserve has seen fit to begin tapering as job growth seemingly slows. Treasury Security Janet Yellen noted the US economy is still short 5 million jobs compared to pre-pandemic times, which will take the US years to recover at the current rate of job growth.
As of writing, the DXY (USD index) is trading at 93.35, down by 0.50% on Thursday trading.
GDP growth in the US may be contributing to this 4-week low in the dollar index. GDP growth missed expectations for Q3 2021, reporting in at 2.0% rather than the expected 2.7%. Q3’s GDP growth represents the lowest value reported for this data point since the US began to recover from the worst of the pandemic.
Supply constraints have been pointed out as one of the major causes for the GDP growth miss, as reported by Fannie Mae earlier in the month. Fannie Mae expects the constraints to continue for another 12 months, although weakening in intensity as time passes.
The USD has lost the most ground against the EUR in the past 24 hours. EURUSD is trading at 1.16831 at the time of writing, up by 0.72% and a one month high for the pair. The cause of the EUR's strength: The public address by the Christine Lagarde, head of the European Central Bank (ECB), playing down any fears of inflation.
While Inflation in the Eurozone is at a 13-year high (3.4%), Lagarde and her ECB associates are not ready to drop the notion that inflation is transitory. The ECB want to see inflation above 2% over the medium term before considering rate hikes or taking a more hawkish tone.
The ECB believes that inflation in the Eurozone has been driven chiefly by supply bottlenecks and energy prices. It could be some time before investors see any change in the dovish stance of the ECB.
Supply constraints are expected to last for a great deal of time, as noted above, while energy prices are yet to show any sign of abatement. The Biden administration has asked energy producers to lift production to help drop the cost of energy. But the request is falling on deaf ears.
At the time of writing, WTI is trading at US $83.04 per barrel, while Brent is trading at US $84.39 per barrel. Both Oil instruments are trading at multi-year highs. The price of Natural Gas does swing widely day-to-day. A 7% swing either way over a day’s trading is not uncommon. Yet, Natural Gas is still trading at US $5.732/MMBtu, more than double the price at the beginning of 2021.
The USD index is currently ranging in between 90.0 and 93.0 and has been for the past six months. Moving forward, the adequate economic data coming from the US should help the weak Dollar regain some of its status, but not a ton. I expect the range to narrow, with the 91.5 level serving as a new support level.
Indices across the board sold off today, making it the 5th session in decline as many investors and traders take high valuations as a good time to take profits.
We have seen Stocks rally in an environment where money is cheap, 1 Trillion dollars of fiscal policy for the United States is not enough, and where the Federal Reserve is buying back 120 Billion Dollars’ worth of bonds every month. Pair this influx of liquidity with many investors and traders being able to save due to lockdowns across the world, and you have yourself a buoyant asset market. And it seems like we will be living in this environment for the foreseeable future.
Chairman of the Federal Reserve Jerome Powell signaled that it would continue to keep monetary policy loose and their bond buyback scheme consistent. With that said, he signals a positive outlook for the U.S economy in 2021. A question on whether rising treasury yields signals an improving economy, Powell replied, “In a way, it’s a statement of confidence on the part of the market that we will have a robust and ultimately complete recovery.” This is interesting as an optimistic viewpoint from the Fed may signal that they may tamper accommodative policies in the near term
However, some analysts are wary about the Fed portraying too much optimism. Steve Friedman, senior macroeconomist at MacKay Shields, stated that “We’re not out of the woods yet when it comes to the virus, and the economy also remains quite far from a full recovery.”
What are you looking at in the markets?
The Dollar Index (DXY) has been positive going into 2021, returning just under 2% year to date. Goldman Sachs. With Goldman Sachs and other large institutions touting their bearish views due to Joe Biden’s stimulus, low-interest rates and an appetite for Gold, the recent strength in the dollar has tested their analysis.
However, with Morgan Stanley abandoning their calls for a weaker greenback, with Matthew Hornbach stating that “It’s no longer attractive to be positioned for a weaker dollar from here given the uncertainties around the fiscal policy outlook, the monetary policy outlook, and the growth and inflation outlook,” are we seeing a turn in consensus?
Analysts are looking at the pace of vaccinations in the United States and worldwide, with predictions being made that a return to normal may be sooner than we think, especially when financial markets and economic policy are concerned. Federal Reserve minutes suggest that a possibility of talks regarding the normalization of monetary policy can start as early as June.
A quicker and more robust recovery may mean Republicans may have a leg to stand regarding a lower stimulus figure. Later this week ahead, we will see the non-farm payroll numbers for January. A higher-than-expected figure may suggest that the American recovery is faster than expected, and a lower stimulus figure from the 1.9 Trillion headline figure suggests. Lower than expected stimulus should put less downwards pressure on the supply side of the U.S Dollar.
With both the U.S Dollar and the Swiss Franc being relative currency safe havens, relative strength in one will bode strong movements in the other. The U.S Dollar has appreciated over 2% year to date, with Morgan Stanley analysts suggesting to short the Swiss Franc against the Canadian dollar while waiting on signs to turn bullish on the U.S dollar.
The Dollar has been experiencing some love coning into the new year, with the DXY up just under 1%. However, is this just a technical rebound, or is there substance for a further rally?
The DXY is currently in a zone where the Dollar has historically consolidated before making a move lower or higher, evidenced by its price movement earlier in 2018. This historical pattern was also prefaced by a strong move downward from all-time highs, which we are currently seeing. This makes sense, as strength in the Dollar usually comes from a sharp exit out of risk assets and more stable assets such as the Dollar.
Before the end of 2014, the DXY struggled to clear 88 after ten years of relative dollar weakness. Coincidentally (or not), this was also the ten year period where the NASDAQ stayed below its all-time high during the bubble of the 2000s. However, once equity markets started their legendary rally in 2013, the Dollar soon followed. It seems like the Dollar follows US equity markets in a laggard fashion due to investors buying into hot US equities after they start to become expensive. Assuming you’re bullish on equity markets, are we going to see a yearlong bull run in the US dollar?
I have stated before that the Dollar has some fundamental headwinds such as Inflation, Quantitative easing, Low-interest rates, and an appetite for assets such as Gold. But these headwinds are irrelevant if global investors increase their appetite for US equities. However, institutions are ratcheting their bets against the Dollar, which has brought bets against the US dollar to an all-time high.
Vasileios Gkionakis, head of currency strategy at Lombard Odier, stated that “The speculative community is very short right now, but there is a good reason: because fundamentals still point to a weaker dollar in the medium term,” stating that the Democratic Party’s 1.9 Trillion Stimulus will push the Dollar down.
Speculate bets against the Dollar may induce a short squeeze if overseas investors plow their capital into US equity markets.
The dollar has fallen from grace from the peak of the Coronavirus. The dollar index is down 10% from its yearly high in March, where traders and investors went to cash.
However, with two strong positive results from two vaccine makers Pfizer and Moderns with their 90% efficacy with their vaccine trial, solid news on when we will get a vaccine will solidify a bull trend and a rotation into value and cyclical stocks.
Calvin Tse from Citigroup wrote in a report, “Vaccine distribution we believe will check off all of our bear market signposts, allowing the dollar to follow a similar path to that it experienced from the early to mid 2000’s.”
We can see that the US dollar has played well around the Fibonacci levels from April 2018 to its high early this year. It is currently sitting at the 78.6 % retracement, looking for targets at the 100% retracement and 168.1%., a full 20% drop.
As we saw at the start of the year, the rally was on extreme risk-off sentiment. Therefore, history suggests that we will only see a strong spike in the US dollar if there is risk-off sentiment, which is unlikely. We should also see some strength in the US dollar once the Federal reserve lifts quantitative easing.
Tse further stated, “There is plenty of reason to be optimistic” on the vaccine, and that the distribution “will catalyze the next leg lower in the structural USD downtrend we expect.”
Mark McCormick, global head of FX strategy at TD Securities stated that "It's likely, short term, [that] the US dollar trades lower on the easing of geopolitical uncertainty", citing that Biden is likely to back away from Donald Trump's confrontational and "America First" trade policy.
What are your thoughts on the US Dollar?
A revival of the Dollar? As we get closer to the election, investors and traders can see one thing in the future – uncertainty. Therefore, we can see market participants start preparing for the unknown.
As debates and the election come up, statements will be said, and policies will be announced to sway the markets significantly. Over the past five days, the Dollar index has rallied 1.28%. The demand for the Dollar may be pointed to investors and traders building up a cash position in their portfolios for two mains reasons
• To take advantage of significant markets swings; and/or
• Want to hedge against market slumps
Many institutional firms are backing the recent rally in the Dollar. Franseca Fonsari, head of currency solutions at Insight Investment, pointed to the election having the "potential to be a significant market mover" and that it would "probably [be] wise" to run lower levels of risk.
Furthermore, Shahab Jalinoos, Head of Currency Strategy at Credit Suisse, echoed Fonsari's comments. He stated that the U.S. election is a key risk that his team considers in predicting a stronger dollar. It is important to note, Shahab has been a bear for the U.S. dollar near the start of August – a point in the dollar decline where it had already depreciated around 7%.
Another currency strategist at Bank of America, Ben Randoll, also pointed to the "substantial economic and event risks ahead" and that he expects a "dollar rally into the election and possibly beyond."
As you can see – analysts are quick to turn their opinion around on a recent turn of event. All three analysts point to the election being a catalyst for the U.S. dollar while remaining bearish viewpoints before the rally. However, it has been clear for quite some time now that the election will be upcoming. Therefore, this is an excellent example of constructing your own analysis and validifying that analysis using technical and fundamental analysis. It's obvious to call a bull run when you're already in one.
I talked about the Dollar earlier this month, and how long term trends such as Inflation, Federal Reserve's Q.E., low-interest rates, and Gold's rise are headwinds pushing the Dollar further downwards. I stated that "Investors [and traders] do not want to hold it" – which I still believe is the long term trend. Future markets show this – showing that most investors and traders are still not betting on the Dollar rallying on the back of a "save haven" trade. Furthermore, put options on the Bloomberg Dollar spot index are still net short, showing a bear consensus.
Uncertainty is coming – stay safe, trade safe.
The dollar has seen better days.
In the past 124 trading days, only 46 has been in the green for the dollar index.
Many factors have catalyzed this risk off-trend, and unfortunately, I believe even the key fundamental strength for the dollar has slowly diminished away during this pandemic.
Inflation in the United States diminishes two things. A) The buying power of the U.S. dollar and B) Real bond yields. Both factors disincentivize investors to hold U.S. dollars. Furthermore, with the Federal reserve implementing a new tool specifically to combat low inflation, it all but guarantees that inflation will rise in the near future, diminishing the U.S. Dollar's power.
The Federal Reserve balance sheet stayed relatively unchanged from 2015 to 2020, dipping below 4.5 trillion near the end of 2020. However, due to the increase of asset purchases to stabilize the financial system, their balance sheet swelled up to 7 trillion at the start of August. The buying back of bonds increases the supply of U.S. dollars in the money market, decreasing the value.
Many overseas investors, including myself, are pleased to hear dollar weakness as it entails, I will get more U.S. dollars when I convert my New Zealand dollars to fund my brokerage account. However, if I wanted to sell positions and covert it back into New Zealand dollars, chances are the U.S. dollar's weakness will erase a majority of the gains made. However, with low-interest rates, institutional investors have found it cheaper to short the U.S. dollar to hedge their equity positions from further downwards pressure.
We saw the U.S. dollar rally against other major currency pairs during the peak of the lockdowns in March as major investors sold off their risk-on assets to hold U.S. dollars. However, as the market reaches all-time highs, the U.S. dollar, with its almost guaranteed diminishing yield, has lost interest from investors in favor of Gold.
This is the main problem for the U.S. dollar. One of the only fundamental strengths that the U.S. dollar has had this year was when there was a rush to hold the greenback in the risk-off period we had in the middle of March/April. However, two things have changed since then:
• Market sentiment has favored Gold in Risk-off days
• "Risk-off "periods like March / April is likely not to occur again
Coronavirus cases continue to pile up in India, United States, Australia, and Europe – however, investors have continued to plow money into the equity markets. To put this into perspective, cases in the United States have only worsened since the peak of the recessionary period in March / April. However, the NASDAQ is up nearly 30% year to date. If the market is a voting machine, it has voted that the new normal is the Coronavirus running rampant everywhere, including the United States. Therefore, anything better than that should boost equity markets. And can things can worse in the United States with regards to the Coronavirus?
The dollar is experiencing significant headwinds, both qualitatively and quantitatively. Investors do not want to hold it, future headwinds like inflation are destined to push it lower, and its only strength is slowly diminishing.
Jack McIntyre from Brandywine Global Investment Management stated that "The dollar has been overvalued for a long time, and this might finally be a catalyst for a multi-year downtrend." Furthermore, he said that "As we've seen before when valuations have been stretched, policy or economic shocks can quickly change the currency's trajectory, and that's what it seems to be happening thanks to the Fed's swelling in the balance sheet, a surge in debt, and the way we handled the pandemic."
Liz Young, from BNY Mellon Investment Management, stated that what we're currently seeing in the U.S. dollar ".. is a pullback.." and that "it is a little too extreme to think the dollar is going to lose its reserve status anytime soon."
Bloomberg also stated that investors and traders are currently net short on the currency, with an increase in demand for puts options on the Bloomberg Dollar Spot Index, cementing a sentiment for a bearish trajectory possibly to a level not seen since 2018.
Anish Lal did an excellent technical overview of the trend of de-dollarisation and its effect on other currencies. You can watch it here.
Rising inflation has been the question many analysts, investors, and traders want answers to. Fortunately, these answers may come soon as Federal Reserve Chairman Jerome Powell is set to take the stage (virtually, of course) to address the future of US Monetary Policy post Coronavirus and, hopefully, answer the myriad of questions regarding the Fed's stance on inflation.
It is the Federal Reserve's mandate to have inflation hover around 2%. However, with low inflation rates before the pandemic, Jerome Powell runs the risk of deflation due to US citizens not being employed.
Analysts predict that the Fed will release a new tool to increase inflation for a more extended period, increasing growth and pricing power. Rick Rieder, BlackRock's Global Chief Investment Officer of Fixed Income, stated that "the rate markets are anticipating the Fed is going to be dovish and willing to withstand inflation being higher for a more extended period.
Currently, the Dollar Index sits just under 93 alongside Gold sitting at $1,943 an ounce. Both are suspectable to change in policies regarding inflation, with both gearing up for a move that would see Gold strengthen and the US Dollar weaken even further if Jerome Powell hints at pumping up inflation.
You always hear people say, "Gold is a safe haven" However, you may not know why, only that when stocks are selling off, Gold is picking up. What is one of the "haven" attributes that people state as a reason for buying gold?
As you can guess by the article – Gold and inflation go hand in hand. That is, as inflation increases, so do, theoretically, the price of Gold. We could go into the nitty-gritty side of things, take out our Econ 101 books, and talk about M1, M2, and M3 money supply, etc. However, what it boils down to is the supply and demand of money versus the supply and demand of Gold.
We all know that the Federal Reserve has been printing money as a drastic attempt to curve the Coronavirus's economic effects on the financial markets. However, this increase in the supply of money risks the devaluation of the US currency. As supply and demand states, an increase in supply, Ceteris Paribus, decrease the price. In this case, an increase in supply implies an increase in spending and demand for goods and services, incentivizing businesses to increase their prices – inflation!
If the price of goods and services increases, one US dollar buys less, therefore losing its value.
However, the supply of Gold is relatively set year over year, alleviating the problem money has as there is no central bank increasing/decreasing the supply. Since inflation does not affect Gold's value, the logic holds that people would instead hold Gold since it will not lose its value through periods of inflation, unlike the US dollar.
Inflation also affects many US dollar-denominated bonds. Bondholders get paid a set amount of interest. However, when inflation rises, the real yield the bondholders get paid gets diminished. Real yield is calculated by the nominal interest rate subtracting the inflation rate. In a 0% interest rate environment alongside rising inflation, sees real yields drop into the negatives. Negative real yields push investors away from the US dollar and into other positive or even neutral assets like you guessed it... Gold.
With all these consequences regarding inflation – why is Jerome Powell insistent on maintaining their 2% guidance? Inflation is essentially a bi-product of stimulus that the Central bank and the government implement. Essentially, the government and central banks' goal is to get the economy moving by increasing employment and increasing the cash households have to spend throughout the economy. An increase in demand for goods and services incentives businesses to increase their prices, hence inflation.
However, there is a more critical reason why Jerome Powell wants to try and spur inflation – its that he does not want the opposite, deflation. Deflation is when prices of goods and services decrease. This is a destructive cycle for an economy to enter into as consumers get into the mindset – "Oh, prices are going to get cheaper in the future? I will just wait then." – However, that is a whole other topic.
For now, all eyes on the head of the money printer, the US Dollar, and Gold.
Anish Lal, an analyst here at BlackBull Markets did some excellent analysis on the GBP/USD ahead of today's speech. You can watch it here.