The USD Plunge Is Artificial, And It Should Sink Deeper

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Includes: UDN, USDU, UUP
by: Narek Zakaryan

Summary

Why is the USD weakening simultaneously with the economic skyrocketing?

The overestimated inflation expectations causes pressure on USD.

The Big Mac Index shows the inconvenience which causes the high US Dollar.

Let's imagine a currency which has a great economy behind it, the economy is doing well, the unemployment rate is at the 16-year low level, the local stock market is soaring to record highs and the central bank has hiked the interest rates thrice during last 10 months. It seems great, and it makes us believe this currency would surge as long as there is not any great depression. At first glance, it is rather unbelievable that during the above-mentioned period the national currency can touch its 15-month lows with no intervention.

So, let's forget about the illusion and let's come back to reality. The described situation refers to the USD. The U.S. economy is doing well, but the USD is heading to the opposite direction.

First, the market was acting on behalf of the USD, as the rate hikes supported the U.S. Dollar Index to increase from 95 to 103 points during the October-January period.

US Dollar Index Chart | USD Index Streaming Chart

Everything was pretty well. The USD was soaring against all other major currencies, the Fed Reserve had a great outlook for the U.S. economic growth and promised more and more interest rate hikes, the new president vowed tax reforms combined with drastic tax cuts, the stock market gave up its fluctuations and skyrocketed to new historic highs and so on... The USD was unstoppable until President Trump warned the market: "the strong dollar is killing us".

He emphasized the competitiveness of exporting goods by saying: "Our companies can't compete with them now because our currency is too strong. And it's killing us," Trump told The Wall Street Journal, referring to competition from China.

Even before this speech the fact that Trump couldn't afford high USD was obvious, as a cornerstone of his economic plan was to persuade the U.S. companies to come back to their mainland, to produce their products inside the U.S. borders, to provide lots of jobs for the unemployed labor force, to provide the industrial and manufacturing development for the country, meanwhile, the high USD would make the U.S. goods more expensive in foreign countries. In this condition the U.S. producers would never agree to invest in the U.S., as the labour workforce is expensive there, the material is also expensive, the taxes were considerably high and even the national currency headed to new high levels. In this situation, the new investors would never benefit.

There are only a few people who consider Trump's words as pivotal for the USD but as there was interesting coincidence among the words and the currency's reversal period, thus we must explore the fact carefully. Evidently, they had to do something which could stop the surge of the USD. What they did, was the creation of an illusion about the soaring inflation, and pledged to hike the interest rate rapidly to curb the inflation. Nowadays market allows the central bankers to manipulate the market with no fundamental base. Afterwards, the inflation was growing at a slower pace. The artificial illusion about the skyrocketing inflation collapsed and made disappointment in the market, the market players stopped to believe the possibility of new rate hikes, the Fed members increasingly expressed their concerns about the slowdown of inflation rate, so the disappointment dampened the enthusiasm of USD bulls, adding more and more pressure on U.S. Dollar. Because of that, the USD lost its ground and the U.S. Dollar Index retreated from its 14-year highs to 15-month lows.

US Dollar Index Chart | USD Index Streaming Chart

Perhaps the devaluation of the U.S. national currency damages its reputation as the main international reserve currency, but Mr Trump's pro-business administration, therefore the USD tumble is very beneficial for the president's plan.

Under these circumstances, we need to forget about any fundamental-technical analysis and to focus mainly on the USD implied exchange rate.

Let's study the Big Mac Index as a price measure to compare the average prices in the U.S. with the greatest trade partners. In the U.S. average price of a Big Mac in July 2017 was $5.30. The 1st destination for U.S. exporters is the European Union, a Big Mac is available for $4.47 there, so you should pay 15.8% less. The second is Canada, where you can buy a Big Mac for $4.66, which is 12.2% cheaper than in the U.S., the third importer of U.S. products is Mexico, where the Big Mac's cost is $2.75, it means you have to pay 48% less than in the U.S., the 4th largest export destination is China, where the Big Mac would cost you $2.92, which is 45% cheaper than a Big Mac in the U.S. These statistics show the great overvaluation of the U.S. Dollar against other major currencies, so it has a great disruptive effect on U.S. producers.

The same conclusion comes after we look at the 10 year-period charts of the U.S. Dollar Index: it is still quite above the average levels.

US Dollar Index Chart | USD Index Streaming Chart

So, the devaluation of the USD is a priority for the U.S. economic development, the fact that the U.S. Dollar's actual exchange rate exceeds its implied exchange rate is a great headache for U.S. manufacturers. The U.S. needs to devaluate its national exchange rate at least 12-16% percent to get equal conditions with U.S. biggest trade partners - European Union and Canada.

So we can expect that the U.S. Dollar Index would decline to 75-80 point zone, as we could notice in the above-mentioned monthly chart the 75-80 point zone is a very heavy support for the USD, and a nice level to trade with EU and Canada.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.