That Time the Dollar Tide Went Out... - Author: Tom Luongo
Welcome to the Dollar Rally to end all rallies. This week’s action in the U.S. dollar puts paid all of the moves by the Fed and the ECB over the past three months to forestall this from coming.
First it was January’s FOMC meeting where the Fed completely reversed course after a very unpopular December rate hike threw equity markets into a tailspin by Christmas.
Of course our Narcissist-in-Chief thought it was all about him and implored the Fed to stop raising rates. It was interfering with his ability to shake down the world at his sanctions and tariffs party.
But it wasn’t about him at all. It was about the Fed’s need to normalize rates into a coming global slowdown after a central-bank-induced, decade-long recovery of dubious merit.
They’d done their job of recapitalizing the banks, somewhat, and now it was time to start trying to address the massive pension system and municipal bond crisis that was on the horizon.
Or at least that’s what they thought.
Moreover, at some point the Fed had to show the markets something positive. That unwinding its balance sheet alongside significant shift in capital flows thanks to Trump’s tax cuts going into effect in 2019 was a signal to U.S. corporations to invest in something other than balance sheet manipulations themselves — buybacks, special dividends, etc.
Trump can talk a good game about the ‘greatest economy evahr!’ but reality is even today’s 3.2% GDP print is marred by one-off items like an anomalous contraction of the trade deficit and huge inventory builds as Zerohedge pointed out.
Let’s not forget how easy it is to get a big GDP print when you’re running the biggest deficits in history.
So what’s the real story. Well, as always, it’s the dollar, stupid, as I said yesterday over at Money & Markets. The dollar synthetic short thanks to that decade of cheap access to them has created a monster not only in emerging markets per normal, but also in developed markets as well.
Europe. Great Britain. Japan. China.
The problem now is that both the pound and euro have broken down out of their ranges and are threatening free fall. The euro broke support at $1.12 and looks for all the world that it is headed to the 2017 low of $1.034. The pound is fairing a bit better, trading just below $1.29 with the February low of $1.277 still in play. A weekly close below that and $1.198 comes into play.
This wasn’t supposed to happen with the European Union winning the Battle of Brexit by keeping the U.K. locked into its death spiral like a peregrine falcon hanging onto a wolverine and getting torn to shreds.
So while we’ve been focused on the Turkish lira, it is the euro and pound that are the worrying ones as Europe now seems to be losing the real war, the one for investor confidence.
The dollar has broken out to the upside despite the best efforts of the Fed, Donald Trump, the ECB and every other philosopher king (and I use that term with as much derision as I can muster) the markets look to to provide guidance.
It’s not terribly complicated when you think about it. A decade of zero-bound and/or negative-bound interest rates have so thoroughly screwed up the market for dollars globally that any small shift in perceived dollar liquidity results in massive volatility.
See the chart below. It is the USDX (in Red) and the percentage of Reserves Absorbed by non-currency factors (in Black) published by the Fed weekly in its H.4.1 report. It says a lot even though the relationship presented should be fairly obvious. As the Fed has changed it’s monetary policy, the percentage of total bank reserves in the U.S. reserved and unavailable for lending has decreased.
As this percentage goes so does the U.S. Dollar Index. Note the extreme volatility known as 2013’s “Taper Tantrum” where the Fed began tapering off its bond purchases. The U.S. dollar took off like a shot once the balance sheet expansion ended.
And that trend not only hasn’t stopped but it is now accelerating during Powell’s Quantitative Tightening. Dollar liquidity is falling rapidly as bank reserves are increasingly becoming more illiquid; needed to cover collateral liabilities.
And to make matters worse currency in circulation has expanded 50% in the past seven years, in case you’re wondering where all the stagflation is coming from.
And It isn’t just a function of the math of a smaller balance sheet, if you’re wondering.
As the Fed let’s the balance sheet normalize the amount of dollars needed to maintain capital adequacy rises. The banks wouldn’t be hitting the reverse repo window or holding huge balances with the Treasury dept. if there wasn’t trouble. Most of the spikes in both of these charts in reserves absorbed (again in Black) coincided with quarterly closes.
In the two weeks prior to earnings the banks would go to the Fed and park a few hundred billion to dress up their balance sheets to report earnings and then drain it out. If you ever wondered why, for example, gold would get hammered in the last couple weeks of the quarter, especially Q1’s, this is why.
And this only scratches the surface of what’s happening as Jeff Snider consistently reminds us as the eurodollar system, the offshore dollar liquidity system, spasmed last May and hasn’t recovered.
Even China has a dollar problem now, apparently. I’m not completely convinced this ‘problem’ isn’t somewhat self-inflicted as China diversifies away from the dollar to assist strategic partners in their struggles against U.S. hybrid war tactics, but “tomato to-mah-to”at this point.
Most importantly this trend is starting to go parabolic and coincides with this week’s breakout of the USDX and the breakdown of the euro and British pound to new lows.
Is is any wonder that Powell is now looking to end QT and commence QE?
Trump and his torturer-in-chief John Bolton are only adding fuel to this fire with their insane foreign policy. Weaponizing the use of the dollar which forms the backbone of your empire will eventually cause that dollar to spike, as it is right now.
Trump, Bolton and Mnuchin feel now is the time to tighten pressure until ‘the pips squeak,’ as Bolton recently put it. But don’t worry, it won’t be his fault when a spiking U.S. dollar boomerangs back on an over-leveraged U.S. economy in ways they can’t conceive of.