The untold double life of King Dollar
The US dollar will remain the currency of our lifetimes.
Dubai - The US dollar has been the world's preeminent reserve currency
Two thousand years ago, the Roman dinari was the world's currency. A hundred years ago, the sun never set on the British Empire (sadly, now it has gone into a permanent eclipse!) and the pound sterling was the world's currency. Ever since 1944, when the Bretton Woods gold dollar peg was created by the FDR White House, the US dollar has been the world's preeminent reserve currency. With the euro in existential crisis and the Chinese yuan crippled by capital controls, the US dollar will remain the currency of our lifetimes. The US economy is a $18 trillion colossus, its banking system the best capitalised on the planet, its role as a geopolitical safe haven a magnet for offshore wealth.
The US dollar index has risen 25 per cent in the past two years, mainly due to the ECB money-printing spree that depreciated the euro (57 per cent of the US Dollar Index) and the relative collapse of petro and emerging market currencies. The US dollar's meteoric ascent was inevitable once Planet Forex realised that the US economy could withstand successive interest rate hikes, as Europe, Japan and China could not. Yet when the Yellen Fed finally raised interest rates in the December 2015 FOMC, the world financial markets went ballistic in early 2016. Crude oil sank below $30 a barrel. The Chinese stock market crashed for the second time in five months. Global bank shares sank amid rumours of Lehman style contagion. The risk premium for high-yield debt and commercial mortgage securities spiked.
Dr Janet Yellen panicked and engineered a policy U-turn, slashing the Fed's projected rate hikes from four to two and doing her best to talk down the US dollar at successive FOMC meetings. The ECB ruled out any additional deposit rate cuts and the Bank of Japan refrained from "shock and awe" bond buying to help the Federal Reserve depreciate the US dollar and ease financial conditions on Wall Street. The G3 central banks succeeded. The US Dollar Index fell eight per cent from its peak late last year.
Oil staged the mother of all short covering rallies. The Chinese yuan stabilised. Credit risk spreads compressed in the US high-yield debt market. Emerging markets currencies like Brazil, Russia soared. Gold rose almost $200 an ounce. My conviction that the Yellen Fed was doing its best to tank the greenback was a major reason why I recommended buying Emaar Properties shares at Dh4.5. Three months later, Emaar had risen 50 per cent to Dh6.85, where I recommended profit-taking as I saw storm clouds gather once more in global equities.
Yellen's speech at Harvard-Radcliffe confirms my view that the hard-money power brokers of the FOMC have engineered a monetary policy coup d'etat at the Fed. She did not rule out a summer hike in the Fed Funds rate, albeit with the usual caveats. Williams, Dudley, Lacker and Lockhart have all dissed her ultra-dovish stance on interest rates in public, with the Boston Fed president Eric Rosengren even going to a Sunday talk show to make his case (Quelle horreur!). Macroeconomics textbooks tell us the Federal Reserve operates under a constitutional dual mandate (maximize employment consistent with two per cent inflation). Wrong. The Federal Reserve operates under a "triple" mandate. A stable yuan and low global volatility and risk spreads are a precondition for a June FOMC rate hike, even if the May non farm payroll or CPI data hits a soft patch.
This is the reason the US dollar has surged to a two-month high since its current rally began on May 5. June is historically a quiet month but this June will be different, if for no other reason than British referendum on the EU on June 23 and the FOMC on June 15. After all, if the Fed wants to implement two rate hikes in 2016 yet preserve its reputation for political independence, a summer rate hike is inevitable. Hence the doji on gold at $1,217. I expect fireworks in the markets after the PCE on Tuesday and the payrolls/wage growth on Friday. This time the wolf is here.
Chicago Fed Fund futures price a 34 per cent probability of a rate hike on June 15 but 57 per cent on July 27. This, of course, ruins my summer, which I had planned to spend in short trips to the Bavarian Alpine resort of Garmisch and my beloved Villefranche-sur-mer. Yet the payoff in locking into another King Dollar rally will be much sweeter on the Zugspitze or the Obersalzberg as in the sunlit wonderland of the Cote d'Azur where Matisse, Picasso and La Bardot once went night fishing in Antibes.