Over the past two days, we’ve looked back at a couple of the six marketthemes I expected to dominate in 2016. Back in January, I said “central banks are in control, be long stocks.” That was theme number one. And I thought “China’s currency manipulation would come home to roost.” That was theme number six. Both have clearly materialized. As for China, its currency manipulation has become center stage with the incoming President Trump.
Among the six themes we discussed back in January, I also expected the dollar to continue on a big run. I said…
“The dollar is in a long term bull cycle—Be Long Dollars
When we look back at the long term cycles of the dollar over the past 40 years, we see five distinct cycles for the dollar. And these cycles have lasted, on average, about seven years. The most recent cycle is a bull cycle, started in March 2008, yet has underperformed the average of the past six cycles. While the bull cycle appears to be long–in–the–tooth, in terms of duration, the fundamentals for dollar strength have just recently swung massively in favor of the dollar. We have an historic divergence in the monetary policy path of the U.S. relative to Europe and Japan—a very rare occurrence to have the Fed going one direction (toward raising rates) and two major economic powers going the opposite direction, aggressively.
This huge monetary policy divergence dynamic creates the potential for a sharp extension in the dollar over the coming months.”
The dollar has indeed been strong, but only after a correction earlier in the year. In the past week, the dollar index has reached a 14–year high.
With the Fed projecting three hikes next year and Europe and Japan still going the opposite direction (full bore QE), the dollar trend doesn’t look like it will slow anytime soon. And despite what many are warning about what a stronger dollar might do to growth, a strong dollar tends to accompanystrong growth historically (and it doesn’t kill it). On the other hand, it should be fuel for the rest of the world, as cheaper foreign currencies give the weaker global economies a chance to export their way out of an economic rut.
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November 17, 2016, 4:30pm EST
As the Trump rally continues across U.S. stocks, the dollar, interest rates and commodities, there are some related stories unfolding in other key markets I want to discuss today.
The Fed: Janet Yellen was on Capitol Hill today talking to Congress. As suspected, she continues to build expectations for a December rate hike (which is nearly 100% priced in now in the markets). And she did admit that the economic policy plans of the Trump administration could alter their views on inflation — but only “as it (policy) comes.” I think it’s safe to say the Fed will be moving rates up at a quicker pace than the thought just a month ago. But also remember, from Bernanke’s suggestion in August, Yellen has said that she thinks it’s best to be behind the curve a bit on inflation — i.e. let the economy run hotter than they would normally allow to ensure the economic rut is left in the rear view mirror. That Fed viewpoint should support the momentum of a big spending package.
The euro: The euro has been falling sharply since the Trump win, for two reasons. First, the dollar has been broadly strong, which on a relative basis makes the euro weaker (in dollar terms). Secondly, the vote for change in the America (like in the UK and in Greece, last year) is a threat to the euro zone, the European Union and the euro currency. With that, we have a referendum in Italy coming December 4th, and an election in France next year, that could follow the theme of the past year — voting against the establishment. That vote could re-start the clock on the end of the euro experiment. And that would be very dangerous for the global financial system and the global economy. The government bond markets would be where the threat materializes in the event of more political instability in Europe, but we’ve already seen some of this movie before. And that’s why the ECB came to the rescue in 2012 and vowed to do whatever it takes to save the euro (i.e. they threatened to buy unlimited amounts of government bonds in troubled countries to keep interest rates in check and therefore those countries solvent). With that, the events ahead are less unpredictable than some may think.
The Chinese yuan: As we know, China’s currency is high on the priority list of the Trump administrations agenda. The Chinese have continued to methodically weaken their currency following the U.S. elections, moving it lower 10 consecutive days to an eight year low. This has been the trend of the past two years, aggressively reversing course on the nine years of concessions they’ve made. This looks like it sets up for a showdown with the Trump administration, but as history shows, they tend to take their opportunities, weakening now, so they can strengthen it later heading into discussions with a new U.S. government. Still, in the near term, a weaker yuan looked like a positive influence for Chinese stocks just months ago — now it looks more threatening, given the geopolitical risks of trade tensions.
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