Might the Dollar Finally Be Embarking on a Substantial Uptrend?

August 6, 2014

For some time now, the potential for significant dollar appreciation against other advanced country currencies has been widely apparent based on divergent monetary policies and the greater economic vulnerability of Europe and Japan to a geopolitical landscape that’s deteriorating by the the week. 

If the dollar is has begun a big move, these remain early days in the move.  The unofficial summer season for currency trading, which lies between the U.S. Memorial Day and Labor Day holidays, is now 76.5% completed.  Since the Friday close before Memorial Day, net dollar gains amount to 1.9% against the euro, 1.4% versus the Swiss franc, 1.2% relative to the Australian dollar and 0.9% vis-a-vis the kiwi.  Not only are these changes comparatively contained, dollar strength has not yet materialized against some notable exceptions.  The U.S. currency has rose only 0.6% against the Canadian dollar and 0.1% versus the yen, and it has weakened 1.2% relative to the Chinese yuan and 0.1% against sterling.  A better argument can be made about the euro being weak than the dollar being strong.

Elements continue to be present that one ordinarily would associate with periods of dollar vulnerability.  It’s a matter of common sense and corroborated by historical fact that the dollar performs better at times when confidence in White House leadership is abundant.  The first multi-year example of dollar appreciation in the floating exchange rate era happened during the early 1980s when President Reagan inspired a rebirth of confidence in America’s military, and the only other example came in the later 1990s when President Clinton delivered peace and prosperity.  Confidence in Federal Reserve policy also influences the dollar.  Paul Volcker reversed the relentless tide of inflation in the early 1980s, and Alan Greenspan’s perceived sixth sense for doing the right thing to keep the economy rolling forward with steady and strong growth, low inflation and well-performing financial markets earned him the affectionate epithet of maestro in the latter 1990s. 

A cacophony of rather personal scorn is being directed these days against virtually everything done by the leaders at the White House and Federal Reserve, and the criticism is drowning out any voices of support and thanks.  One sees the net impact on sentiment toward President Obama in his slip-sliding approval ratings.  Likewise, the Fed prevented deflation with 20% + unemployment but one only hears about the ballooning central bank balance sheet, a policy that protected bankers and other wealthy citizens at the expense of ordinary people, and a timid exit strategy that opponents claim will return the United States to high inflation.  This is not a backdrop for sustained, broad-based, and extensive dollar gains.

That still doesn’t rule out a temporary breakthrough.  Euroland has experienced two recessions since 2008, and recent data cast doubt on whether its nascent uptrend has a good pair of legs.  Less fruit from Abenomics is now getting picked in Japan.  Germany and Japan have bad demographics.  Geopolitical tensions in Ukraine and the Middle East threaten the economies of Europe and Japan more seriously than the United States.  The U.S. economy also could tolerate weaker-than-assumed Chinese demand much better than most other countries. 

However long it takes the Fed to enact its first interest rate hike, it’s quite apparent that this will happen before either the ECB, Swiss National Bank, Swedish Riksbank or Bank of Japan do likewise.  The dollar will benefit in advance by the Fed being first.   The yang of this ying is that America will become the test case for whether any economy dependent for so long on ultra-easy monetary policy — and without an external growth impulse like the Second World War after the Great Depression — can handle interest rate normalization.  Japan couldn’t when the Bank of Japan tried in 2000.  Fed officials are right to say that tools exist for mopping up excess liquidity.  The big uncertainty is whether any speed that governs that process with prove safe.  Chances for success would be improved if the dollar is not rising sharply when normalization is engineered.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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