USD Outlook: Short Term Up; Long Term Down. Here's Why

Despite the justified talk about the USD losing its position as a premier reserve currency and trade benchmark status, it's critical to keep some perspective.

For the Near Term

A Near Term Stock Pullback Is Likely and Should Boost the USD

At present, the only short term reason to hold the USD is because it will benefit from the coming stock pullback and massive USD short unwinding. That, however, is likely to happen and could be a multi-month boost for the USD if the global economy lurches into decline for a double dip recession or even just period of stagnation.

The USD is due for a rally over the coming months both because the USD itself is oversold and the global equities are still way overvalued/overbought. Most of the time, world stock markets, which are usually best represented by the S&P 500, drive risk and safe haven asset prices. The dollar continues to behave like the #2 most safe haven currency after the yen. Thus the sharper and more sustained the pullback, the higher and longer the USD rally.

When that rally peaks, it will be time for those with short term time horizons to get out of USD assets as much as one can.

Even A Worst Case USD Collapse Unlikely for Many Years

Although there is plenty of talk about a sudden collapse in world demand for US debt, such talk strikes one as naïve. In a worst case scenario, which even the current US policy team is unlikely to allow, it's hard to imagine such an event happening for many years.

Why? Because most of the world still very much needs the US currency and economy and will continue to buy its debt and do whatever can be done to support the dollar out of pure self interest.

Virtually every major economy still holds a huge portion of their foreign exchange reserves, typically over half, in dollars. None wants to see those wiped out by a dollar collapse.

The export economies like Japan, the BRICs, OPEC countries, etc, do not want to see their own still massive USD reserves wiped out, nor their best customer destroyed. Thus they will do all they can to keep their best customer afloat, ( just like US banks lent money to questionable debtors in order to keep their revenues flowing and people employed) at least until they can find other markets to fill the gap the US would leave. That will take time. Yes, they could well get hurt in the long term holding that debt, but leaders tend to deal with short term problems and leave longer term issues for later, or for their successors.

Long Term USD Trend Is Still Likely To Be Down

However, because there has been no change in the fundamental weaknesses of the USD, in the longer term i.e. over the coming years, there is no reason to believe at this time that the USD's downtrend will not resume.

Likely events that could yet save the USD:

1. Stock market pullback - likely. The USD still behaves as a safe haven currency for which demand rises in times of fear, especially given the extreme number of USD shorts that will need to buy dollars in order to exit their positions. As long as unemployment remains a problem, incomes, consumer spending and ability to repay debt will be weak. That means that GDP (70% is consumer spending), banking and housing, the sources of the current crisis, will remain troubled and likely lead stocks back down. It's unclear how long stocks will drop or stay down, but that's likely to be a matter of months, not many years.
2. Fed starts raising rates – very unlikely. Jobs and personal income are at the heart of the US recovery story, until these improve, there can be no meaningful US recovery. (though jobs growth has typically been a lagging indicator). Why? As noted above:

• 70% of US GDP is consumer spending

• the banking and housing sectors, which led the US in and will lead it out of the current crisis, cannot recover unless Americans can pay their debts and spend enough to allow commercial real estate and debt to recover.

Low rates also keep the USD low and make US exports cheaper.

Finally, while the Fed has all the above incentive to keep rates low, it doesn't have strong reasons to raise rates in the near term. As noted above, large foreign holders of US dollars and debt may complain about the dollar, but they still need it and the US economy, so they will not walk away from US debt purchases, though they can and will do all they can to diversify more out of the dollar.

Relative USD Strength—Possibly

Currencies trade in pairs, one valued against the other, so it's all relative. For example, a currency like the euro has had a huge run against the dollar, but not due to any major improvements in its own underlying fundamentals or interest rates. Rather, the USD was getting weaker and sentiment was turning sharply against it. This relativity can work in favor of the USD if another of its major crosses experiences new troubles, as long as the dollar doesn't also appear to be deteriorating.

Coordinated International Support – Likely

For reasons stated above, the US and the rest of the developed world will come together – fast, to lend support if the dollar really gets in trouble.

The likely USD trends are:

• For the short term (coming weeks to months), up.
• For the longer term, down – but not out, and with very tradable bounces.

Disclosure: long USD, UUP.

Comments

[User 353732:]

1. When a currency, company, industry or even society collapses at first the descent is gradual and fitful with several reversals. This creates the comforting received wisdom that the decline is really just an aberration and the days of glory will return, or the decline is not so terrible and we can adjust or the decline is so far away that there is no compelling reason to worry, change behavior or operating model or culture. Delusion is the norm and mocking those who argue from facts, history, and direct experience is a popular spectator sport.

2. However, as we have witnessed repeatedly, the tipping point comes suddenly. There are no grand announcements or warnings. Even a minor event can become the catalyst for sudden and catastrophic collapse. Suddenly that which was denied or obscure to most becomes inescapable and clear. The world changes.

Of course, hardly anyone(unless gifted beyond mortal ability or astonishingly lucky) can predict the moment of collapse but that does not mean no collapse is possible or is far distant. The strongest argument against dollar displacement is that it has not happened yet but that is the argument that is always made before all great turning or tipping points, whether economic, financial, social, military or technological.
The evidence is accumulating : neither the net worth nor the income generating capacity of the US can support the fiat dollar at its current rate of demented expansion. Nations, companies and investors are ,with increasing insistence, calling for a new model of storing value and conducting exchange; investment flows into proto-currencies are increasing and transactions that seek either tactically or strategically to by pass or route around the dollar are manifestly increasing.
Evidence of denial and suppression of the truth by the US Regime is also increasing. Allowing financial monsters to claim regulatory or deferred tax assets as real capital is a pathetic fraud; allowing banks to claim that incontestably non-performing CRE loans are performing(via regulatory fiat) is desperate, deranged and demonstrable deception on an epic scale.

Investors and ordinary Americans do not know when the dollar will collapse but contingency personal and portfolio planning to protect themselves and their families is surely prudent. Facing dollar degradation fears is the first step in either meeting or overcoming them.
What if the collapse occurs sooner rasher than later? What is the plan then, besides continued denial, refuge in delusion and the usual blustering complaints that we are just innocent victims and someone, somewhere, better make us whole or else.....The world, this time, will respond by saying "or else, what?"

Nov 01 08:09 AM

[LilBob:]

"the banking and housing sectors, which led the US in and will lead it out of the current crisis, cannot recover unless Americans can pay their debts and spend enough to allow commercial real estate and debt to recover."

That's the rub right there. Essentially that statement is tantamount to saying that we need American consumers to bail out overly optimistic real estate speculators who built like fools. Consumer deleveraging is ongoing and is likely to take several more years. Once consumes have dug themselves out of debt, don't expect them to go rushing to bury themselves again. Even if employment does start to pick up wages for the typical working class American are going to be stagnant for many years as domestic job competition now complements out-sourcing as a means of pushing down wage-rates. Someone who's making $300/wk stocking retail shelves isn't going to be able to bail anyone out. Also don't forget that housing still has a long way to fall as we are comparing property values to base-lines that existed prior to an additional 3 to 4 years of out-sourcing of jobs. This country still hasn't seen the full effect of ghettoization that will occur as a result of the transition to a service and retail based economy.

Nov 01 08:12 AM

[Dave Wrixon:]

The Dollar as a safe haven is a fallacy. Your own arguments show as much. If after a few months it is going to continue to decline in value, how can be it be a Safe Haven. Sorry, the World fell for that one last year, but once bitten, twice shy.

Nov 01 08:15 AM

[Mad Hedge F...:]

xgu ) If someone mentions the word “decoupling” to you, turn around and walk away, delete their number from your Blackberries and I-Phones, delink from their Facebook page, and block their Tweets and e-mails. Knowing this individual will be seriously injurious to your wealth. When the stock market rolls over, don’t expect to be able to hide anywhere, except in cash. The way all assets classes simultaneously piled into the “down” elevator at exactly the same time last week is proof of how highly correlated markets are these days. The causes are mega hedge funds with newly tightened risk controls and itchy trigger fingers, vast quantities of stock electro shocked by computer algorithms, and too recent memories of the bloodletting earlier this year. I have always viewed diversification as a great way to lose more money in varied places with more exotic sounding names. Remember the old saw that when America sneezes, the rest of the world catches cold? Now when the US says “katchoo”, the everyone else catches the H1N1 virus, AIDS, and the bubonic plague. The US has become on the canary in the coal mine that warns of deadlier global contagions. There is really only one trade these days. Is the world getting better, or not? Only the volatility will vary across instruments and countries. As much as I love China (FXI) and commodities for the long haul, when the US markets drop, I expect them to plummet twice as fast.

Nov 01 08:16 AM

[Roger Knights:]

"1. When a currency, company, industry or even society collapses at first the descent is gradual and fitful with several reversals. ...

"2. However, as we have witnessed repeatedly, the tipping point comes suddenly. There are no grand announcements or warnings."

Here's a quote from a great recent article, "the trend is your friend until it ends": "Pear-shaped situations require pear-shaped analysis." Here's the link: seekingalpha.com/artic...

Nov 01 09:22 AM

[adan:]

nice overview, thanks!

in regard to (from the article) :

"...because there has been no change in the fundamental weaknesses of the USD, in the longer term i.e. over the coming years, there is no reason to believe at this time that the USD's downtrend will not resume...." -

and THE most fundamental weakness, i believe, unbalanced budget (excess debt and debt service), though agreed to by our own elected representatives, is and will ultimately be seen as the responsibility of the people who continue to put those kind of representatives in power...us.

i truly believe, as the average american continues to learn about finance, and takes responsibility for "keeping up," there's a "chance" our country will once again belong to most of us, and not the few of us....

Nov 01 07:36 PM

[Cliff Wachtel:]

My bad-Clarification for the forex newbies:

The Term "Safe Haven" as applies to currencies means that traders sell it off when risk appetite is rising (optimism)and buy it when risk appetite is falling (fear, like the past week). Observe how the USD has behaved when markets rise/fall over the past 2 years proves this.

The term makes NO statement about the currency as a safe store of value -- indeed you correctly point out the label is rather ironic as applied to the USD. Some of the so called "risk currencies" [ie bought when markets are rising and falling when markets fall] are in fact far more fundamentally safer and backed by much healthier banking systems eg the CAD -- that are not burdened by mountains of bad subprime and related loans and economies not burdened by the associated bailouts.

For reasons beyond the scope of this comment (see my recent post or instablog: stocks vs currencies-which moves which and why for a bit more explanation) the USD DOES INDEED drop with rising stocks and rise when they fall, earning it the somewhat confusing "safe-haven" label, but it is by no means the safest store of value.


On Nov 01 08:15 AM Dave Wrixon wrote:

> The Dollar as a safe haven is a fallacy. Your own arguments show
> as much. If after a few months it is going to continue to decline
> in value, how can be it be a Safe Haven. Sorry, the World fell for
> that one last year, but once bitten, twice shy.

Nov 02 11:39 AM

[Formyx:]

If the long term is down there is no reason for it to be up in between.

Nov 03 08:23 PM