Markets were all on watch for Fed chair Jerome Powell’s testimony to congress in order to get more information on the Fed’s next step.
This is where we are now. Markets are waiting for a confirmation of cheap money. The Fed mandate is to keep assets propped. The Fed is taking signs from the market and acting upon them. They need to keep assets, especially stocks, propped.
The rate cut at the end of this month is now 100% certain. The question is now whether it will be 25 or 50…the market has already priced in 25 in my opinion, and perhaps can still sell off once the Fed actually cuts because it wanted a 50 basis point cut.
Again folks, the bond markets is what told us that a cut was coming. Financial media and others want us to focus on the stock market, but it really is the bond market that tells us where everything is going.
On a side note: the Fed also needs to cut because of debt levels. Not only are consumers piled with debt, but so are world governments. Both need access to cheap money and need lower rates for interest payments. Financial media spins this by saying “consumer credit is expanding” this sounds positive when they add it is for purchasing homes and for goods and services. It paints the consumer in a strong way. However, what they really are saying is, “consumer debt is rising”. See the difference? This is how they spin it.
So now that we have covered interest rates, let’s talk about the big elephant in the room: the US Dollar.
Many are now saying the the US Dollar will be going lower. In fact this is a reason why central banks do cut rates, to weaken the currency. We also know that President Trump wants a weaker Dollar too. Everyone else is weakening their currencies for exports, so why not the US too? That is President Trump’s thinking.
Here is a chart of the US Dollar (DXY). The black line above is the important psychological 100.00 level. The blue line below the black is the recent highs, while the final blue bottom is the 95.00 zone. I still believe the US Dollar will be going higher. My stance would change if we break below the 94-95 zone.
I have three reasons for why the US Dollar will still be going higher even when the Fed and President Trump want a weak Dollar…this means that in the future, the US and the Fed may have to find a way to “kill” their Dollar…maybe even a new Bretton-Woods type conference. Remember, as the US Dollar gets stronger, all the problems in the world exacerbate, especially in emerging markets where there is Dollar denominated debt. We are already seeing these effects in India and Turkey, where the strong Dollar has destroyed the Indian Rupee and the Turkish Lira…so much so that both nations favour buying oil from Iran because they do not have to pay for energy with US Dollars…at a time when they really cannot afford too.
So here are the three reasons the Dollar will still go higher:
1)Reserve Currency and Petro Dollar.
It is more about the reserve currency rather than the Petro Dollar, but we should speak about the geopolitical possibilities.
When things in the world start to go crazy, people will run into the US Dollar. This doesn’t mean Gold will fall…it is possible to see BOTH Gold and the US Dollar rise and I argue we will see this. Remember, Gold goes up when confidence is running out in government, banks and policies. It is a confidence crisis asset. With the Fed now beginning a rate cut cycle, it is likely we may go back to QE…which was supposed to be a one time, desperate policy, but many are realizing that this will now be the norm.
However, many still see Gold as this useless, non yielding asset. These people will naturally run into the US Dollar.
America also has the exorbitant privilege of being the reserve currency. Meaning there is always an artificial demand for US Dollars, and the Fed can keep printing as many dollars as they want without caring about debts and deficits…unless Dollar demand takes a hit or the US loses reserve status.
This is where the Petro dollar comes into play. Currently Iran is the threat because the Iranians take any currency besides the US Dollar for their oil. As mentioned before, countries like Turkey and India love this because their currency priced in US Dollars has gotten decimated. European nations, Japan and South Korea have followed suit, but have reluctantly dropped due to US demands. Turkey and India really cannot afford too.
Russia and China are trying to attack this Dollar demand, and Iran is the key for them. Venezuela is also, but her oil production needs to come back to par, and believe me, Maduro will remain President backed by the Russians and the Chinese solely because he will announce Venezuela will NOT take US Dollars for their oil. This is part of Russia and China’s plan. Gold does play a part in settling payments too but I have covered that in other blog posts.
In a way, this is why war with Iran is more than likely to happen. It is the way the Americans will protect their US Dollar demand and the role as reserve currency. They will force all nations to use the Dollar for energy. In this way, the US army and other western armies are the armed branch of the Federal Reserve.
What adds even more probability to this is the fact that the US is the largest producer of oil, and will very soon be the largest NET EXPORTER of oil, overtaking Saudi Arabia and Russia.
2)The US looks better than other western nations
This is thanks to tax cuts implemented by President Trump…and other western nations are being burdened by large tax rates as governments need to tax more in order to spend more. Partly why they want inflation. More taxes in terms of more money through property tax and sales tax etc.
All other western nations will also be cutting interest rates. Australia has already cut twice this year, taking them down to 1.00%. Other nations will also follow along. In this environment, what would you rather hold? Would you still want to hold the Euro or the Canadian Dollar? I don’t think so.
If you factor in that all western nations will be cutting rates, the US still looks the best. Martin Armstrong calls this the “prettiest sister out of the three ugly sisters” situation. That the US Dollar is the prettiest sister out of the three ugly sisters (other western currencies).
3)US Treasury Demand
We end up looking at the Bond markets again.
Now this is the most important reason in my opinion. For fixed income investors, US treasuries still provide the best safe yield for bonds.
Fixed Income products are huge for pension funds. In fact US Social Security is 100% composed of government bonds!
There is about 12 Trillion Dollars worth of negative yielding debt in the world right now! Put yourself in the shoes of a German fixed income manager. Would you buy European or German debt yielding very low, even zero to negative! Or would you rather buy US Treasuries yielding a decent amount compared to other western counterparts?
I have argued in the past that the rise in the US Dollar is because of European money coming over (having to buy the US Dollar in order to purchase US Treasuries or even US stocks). This will continue to increase and it will not just be European fixed income managers doing this. In fact, US Treasuries is the best way for foreign funds to obtain US Dollars.
So these are my three reasons for why I expect the US Dollar to rise. Because the demand for US Dollars will still be there. Brent Johnson also speaks about this with his Dollar milkshake theory.
In the end, the Fed and the US government will be forced to kill the US Dollar because cutting interest rates (maybe even to zero or negative) will not cut it. The Dollar will still strengthen, and as it does, the worlds problems exacerbate. The world will demand some sort of relief and will likely lead to another Bretton-Woods type conference. I argue it ma even be a return to hard/stable money…but I have argued it will probably lead to a digital currency so money can be traced and taxed (required for MMT and other helicopter money policies).
So in the end, the US Dollar will fall, but I believe there is still one more push which will cause problems as mentioned, especially emerging markets. It seems we are inching closer to this scenario, with confirmed rate cuts being the beginning. Interesting times ahead to say the least.