Pessimism over the dollar will be shortlived

The leveraged US dollar carry trades are back.
In recent weeks, the dollar has slipped versus many currencies, for which most analysts blame the unseemly spectacle of the debt ceiling drama in Washington and the fact that the world will continue to be flooded by liquidity from the US as possible tapering recedes once more into the distance.
There is still widespread disillusionment with the US government and Congress.
Moreover, there is gathering evidence that quantitative easing is not having the desired effect on the real economy as macro data in the last two weeks has been largely downbeat.
September’s payroll report was soft while the figure for core capital goods shipments was disappointing, suggesting business activity was muted even before the government shutdown.
Housing sales fell more than any other month on month since 2010.
“What is appearing in the data is a stubborn inability of the economy to reach escape velocity,” notes Michael Feroli, an economist with JPMorgan in New York.
At the same time, on a more micro level, this season US companies have not produced stellar earnings and revenue per share actually fell. There are no signs of a revival of capital spending despite the continuing low cost of capital.
Yet pessimism over US economic prospects and over the dollar are both likely to be shortlived.
It is clear that at least for the time being US equities remain the biggest game in town. This week, once again, the US equity market hit record highs. Unsurprisingly, much of that equity investment involves leverage, and leverage can mean instability. Stock margin debt at the New York Stock Exchange was a record $400bn at the end of September, according to data from CLSA.
Meanwhile, data on trade flows and foreign exchange reserves in most countries show, and most investors believe, that for now there is no alternative to the US dollar.
“Under what conditions can the US remain weak and the rest of the world not be even weaker?” asks one Hong Kong-based credit hedge fund manager.
“If the US stays weak the rest of the world will weaken even more.”
For example, two weeks ago, Agricultural Bank of China surveyed large investors in its Hong Kong-listed shares to ask them if they would prefer to receive their dividends in Hong Kong dollars, linked to the US dollar, or in renminbi. Just days after the debt ceiling debacle was resolved, the answer was overwhelmingly Hong Kong dollars.
As of the end of the second quarter, the share of the dollar in global reserves increased 0.9 per cent to 60.9 per cent compared to the end of 2012, according to IMF data.
“The resilience of dollar assets remains clear against a backdrop of global turbulence,” note the economists of JPMorgan, despite the fact that it is the US that is the cause of much of that global turbulence.
That leaves two questions: for how long does the disconnect between the liquidity fuelling the markets and the message from the real economy prevail and what could bring that disconnect to an end?
It is hard to come up with a potential economic or credit shock.
Inflation would bring the Fed to reconsider its easy stance but so far deflation remains a bigger threat than inflation. Import prices are down 1 per cent over 2012 currently.
That means that the superficial similarities with Japan, where it is clear that the economy has lost momentum and the stock market has been down on disappointing growth in earnings from such bellwethers as Komatsu, are not really relevant. Few analysts would suggest that the US is plagued by the long-term structural ills of Japan.
While the Fed meetings this time around are not expected to cause jitters, the next big test will be the confirmation hearings for Janet Yellen.
There are some investors who believe that Ms Yellen will sound a more hawkish note at that point to satisfy sceptics on the hill and to protect the balance sheet of the Fed itself. But every day, the opportunity cost of such a cautious stance seems greater.

Henny Sender

Fonte: FT