Thoughts on How the Dollar Might Perform in 2020

January 13, 2020

Lessening Dollar Volatility: Closing quarterly quotes for the euro against the U.S. currency last year painted a tight shot group of $1.1217 in 1Q, $1.1373 at midyear, $1.0900 in the third quarter and $1.1219 at yearend. If one substitutes dollar/mark for EUR/USD for years prior to 1999, the 4.3% spread between the most disparate of those four quarter-end observations in 2019 tied 1996 as the third and fourth least volatile year after spreads of 4.1% in 1995 and 4.0% in 2015. Next in that ranking at fifth place was 2012. With three the five least volatile years happening last decade, the tendency for a steadier dollar looks like an enduring development.

Irrational Exuberance — Fact or Fancy: A 28.8% increase last year in the S&P 500 U.S. stock market index was the sixth double digit advance in the last ten calendar years and the second largest in the bunch after a 19.6% jump recorded in 2013. The third best year with an increase of 19.6% occurred in 2017, and the 7th best year — a 9.4% — just missed double digit territory. Only the 6.2% decline in 2018 surpassed 1.0% in size. Juxtaposed with the historically elevated price-earnings ratio of the stock market, U.S. economic growth is slowing under the weight of diminishing global growth, the fading effect of President Trump’s 2018 tax cut, and trade war concerns that have dampened business investment. Real GDP grew just 2.1% between the third quarter’s of 2018 and 2019, which is lower than calendar year growth in six of the seven years from 2012 to 2018. America’s economic upswing began in the middle of 2009 and is the longest already of the post-WWII ear.

Political Uncertainty: Concern that a U.S. recession could start either this year or early 2121, fears of war, and a presidential election that may offer a choice of unsettling policy governance extremes are a plausible recipe for falling confidence in America that would make the past three years a mere appetizer for what lies ahead. At the least, the 2020 election is shaping into a no-holds-barred nasty fight to the finish. The incumbent Republican president has broken all sorts of policy and stylistic norms, and the leading Democrat in the Iowa Caucus is a self-proclaimed socialist, who was born prior to the Pearl Harbor attack and who suffered a heart attack just last year. As one precedent from the late 20th century during the time when Watergate evolved from a third-rate burglary into America’s only presidential resignation, the DOW tumbled 45.1% in 694 days from January 11, 1973 to December 6, 1974. In that span that also included a quadrupling of oil prices, the dollar came under great downward pressure, necessitating the abandonment of fixed dollar parities against other currencies followed by waves of depreciation in a newly created flexible exchange rate monetary system.

Downside Dollar Risks Aren’t New and Haven’t Hurt the Currency So Far: On a yearend-to-yearend basis, the dollar rose against the euro in 2019, 2018, 2016, 2014, 2011, and 2010. Despite softening this year, U.S. real GDP growth is likely to continue exceeding the expansion rates of Germany, France, Italy, Switzerland, U.K. and Japan. The dollar stayed well-bid in 2019 despite three Fed rate cuts that a year ago were unforeseen and  76-basis point decline of the 10-year Treasury yield that surpassed the net 43-basis point in the German bund counterpart. U.S. military involvement in the Middle East has been the norm for two decades. However grim the geopolitical news gets, the markets’ threshold for such distractions has soared in tandem.

Dollar Lacks Formidable Competition: China’s reliance on market mechanisms failed to be accompanied by a parallel shift toward democracy. The yuan doesn’t have the structural pre-requisites for an international reserve currency and will never obtain such so long as Xi Jinping Thought guides that country. Japan might have become a contender if it hadn’t pursued a xenophobic immigration policy long before such became popular in many other countries. It’s been two decades since Japan’s economy fell into a rabbit hole of alternating deflation and low inflation, spiraling public debt, declining population, and very weak growth, and the Nikkei-225 remains light years below its end-1989 level of 38,916. Euroland’s economic problems foremost stem from an unwillingness to pair economic and monetary union with greater fiscal unification. Brexit, tattered relations with Washington, and a new and untested ECB president will greatly complicate the high level of uncertainty facing countries that share the euro. Existential doubts about the euro’s endurance continue to prevent the currency from challenging or even sharing a piece of the dollar’s  hegemony. Between the Brexit referendum on June 23, 2016 and the end of this month when the U.K. will actually leave the EU, the British economy performed better than feared, and sterling stabilized after hitting its low early in that time span. One cannot assume that Britain will continue to do better than the worst-case scenarios, and even without Brexit, there never was any realistic possibility of sterling recapturing its early-20th century stature.

Markets Move Mostly on Truly Unimaginable Developments: This is why FX forecasting can be so humbling. It’s the unknown unknowns even more than the known unknowns that propel the biggest swings in currency markets. In 1979-80 when bank CD rates surpassed 15%, who expected to see 40 years of near uninterrupted disinflation? And not many people were talking about climate change, then either. When state presidential primaries were widely expanded as a means to chose political party candidates, their introduction was greeted as an enormous step forward in American democracy, not the dagger in the nation’s heart that such turned out to be. Likewise, the unforeseen dark side of on-line social media in just a decade has overwhelmed the benefits that were recognized at first.  As noted above, President Trump’s perpetual outrages have numbed investors into disregarding all sorts of developments that used to influence the dollar immediately and sharply. If 2020 proves typical, it’s likely to be remembered for things not currently on the front burner, and the direction and magnitude of movements in the dollar will be shaped critically by future surprises rather than already identified trends.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

 

 

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