Will The Japanification of Europe Help The U.S. Dollar?

With the daily chaos in Washington and policy and political uncertainty in major money centers around the world, it is no wonder that divining the direction of currencies, has become a full-time profession for many. This year’s annual  TradeTech FX conference assembled numerous foreign exchange professionals to debate the direction of the U.S. dollar against G-10 and emerging market currencies.

At last week's conference, dollar bears cited numerous reasons why they believe that the dollar is too expensive against the Euro, yen, and sterling, and why it is likely to decline against those currencies later in the year.

• China is using all possible monetary, fiscal, and bank credit stimulus tools to stem its growth rate slowdown; hence, there is room for the Chinese renminbi (CNY) to appreciate against the dollar.
• The trade war between China and the U.S. is lingering longer than expected.
• The Euro is being used to fund the emerging market carry trade. Also, the Euro is being used for hedges against Brexit.
• The U.S. current account and trade deficits have to be to be reconciled either with higher interest rates, tax increases, and/or budgetary cuts.
• Euro, yen, and sterling are undervalued, so there is room for them to appreciate against the U.S. dollar.
• Many emerging market currencies could do well against the U.S. dollar, since the Fed is unlikely to raise rates more than once this year.

According to Steven Englander, Head of Research and Strategy at Rafiki Capital Management “Despite overwhelming positive dollar news, there has not been dollar buying you would have expected. As soon as market gets positive tone, investors buy emerging market currencies that got beat up last year.  The U.S. economy is stable economy, one of the most exciting we have encountered in the last 50 years. It is growing, at 2%, but that is not exciting investors.”

Ulf Lindahl, Chief Investment Officer of A.G. Bisset Associates did a great job explaining to audience members that “fifteen-year currency cycles exist and they repeat. Euro’s average gain in upward phase was +114%. The average duration of the upward phase is about eight years.  I expect the dollar to go down.  Against the dollar, other currencies are at their cheapest in 30 years. This is being driven by the global economy.”  He also emphasized how undervalued a number of G-10 currencies are against the U.S. dollar. “Sterling is 27% undervalued, and the yen and the euro are undervalued 37% and 22% respectively. This cycle will be reversed.”

Helping Asian currencies appreciate against the U.S. dollar will be China’s economic performance.  It is difficult for economists and market participants to get a good reading of what is happening in China, because it is very opaque, and data are not reliable.  According to Win Thin, Global Head of Strategy at Brown Brothers Harriman, it is important to note what Chinese policymakers are doing with huge monetary and fiscal stimulus. “This means there are big concerns from the government. They are worried about people getting very upset if the economy slows down.”  Thin emphasized that this is the “most worried about China” he has been in his career. “The trade war has been going on longer than anyone thought. It is not a disaster, but we should be cautious.”  According to him, “China not to implode. It will muddle through.”

Dollar bulls, however, strongly argued that the dollar is really the only name of the game and cited the following reasons in support of their position.

• The dollar is a reserve currency and held by numerous central banks and other financial institutions.
• All commodities are priced in dollars.
• The dollar benefits in very good U.S economic times or when there are problems elsewhere, there is a flight to safety. The U.S. dollar is like the Swiss franc, a safe haven currency.
• S. is now an energy exporter, which puts it in a very strong position economically. Europe is an energy importer.
• While U.S. growth is likely to slow down, we are not in a recession and few economists are predicting one soon.
• Data from continental Europe, is showing that the Eurozone is barely escaping recession.
• Banks in Europe have not recovered fully from the financial crisis in the same way that U.S. banks have, so that will hurt the Euro against the U.S. dollar.

Alessio De Longis, Vice President of OppenheimerFunds “The Japanification of Europe is here. The Euro is no longer behaving like it used to. The European Central Bank (ECB) has used up its monetary policy arsenal.” As did a number of other dollar bulls, De Longis pointed out that ECB has “no more room to ease. Europe is on the verge of a recession, and the financial sector in Europe is broken.”

For Marc Chandler, Managing Partner and Chief Market Strategist at Bannock Burn Foreign Exchange, “Exchange rates are good way to look at market sentiment. Almost every emerging market [EM] currency has given up post FOMC [Federal Open Market Committee] gains. The low interest rate story is not enough for the EM rally. I do have questions about growth in the US, Europe, China, and Japan.”  In light of a global slowdown, low interest rates in the US and Europe will not be enough to push emerging market currencies up against the dollar.

Chandler also explained that he is bullish on the dollar, because “the US was the first to get into the financial crisis and is the first out. That divergence is not over. Bad weather in the U.S. has hurt the first quarter. However, the government shut down is over.” He also believes that trade problems with China as well as Brexit “will get kicked down the road.”

With all this information, it is important to consider what should be done with currency portfolios.  Chandler has advised clients to “hedge Euro receivables based on forward pricing and volatility.  Lee Ferridge, Head of FX Strategy at State Street Global Markets was “negative on Australia. It is a high beta currency. Housing prices have been rising and the US-China trade situation not solved yet. This will hurt the Aussie against the dollar and the yen.”

Andrew Busch, former Chief Market Intelligence Officer at the Commodities Futures Trade Commission, said that he did “not like emerging markets, the Brazilian real and Russian ruble just smell.” However, he did say that there could be some good opportunities due to volatility.

Robert Savage, CEO of CCTrack Solution was unequivocal that the dollar is the name of the game. “There is a high risk of central bank intervention to cap the rise of the dollar.” He also said no matter the result of U.S.-China trade talks, “Trump will declare victory and move on; he has done this on other issues.”

“There is no real competing currency against the dollar,” said Ben Emons, Senior Strategist at Medley Global Advisors. “Central banks have tried to move away, but results have been minuscule.”  Like De Longis, Emons believes that “Europe is moving to Japanification; the yields showing this. Europe cannot get out of the Japanification trajectory.”

While an informal poll at the TradeTech FX conference, showed that the majority of participants were bearish on the dollar, the bulls persuaded me to lean their way. I have been attending and presenting at this conference for five years, and I have to confess that I am already looking forward to TradeTech FX 2020 to exchange views with such varied conference participants from all over the world.