The Most Important Price: The Price Of The U.S. Dollar

| About: PowerShares DB (UUP)

Summary

Over the past 12 months, the value of the US dollar against the euro has fallen by 14 percent.

Although the recently passed tax bill may temporarily help the US economy and the US dollar in the short-run, the hopes for the longer run are not good.

Investors seem to be saying that European growth and European productivity will be stronger in the future than that achieved by the United States, and this weakness will hurt dollar.

Former Federal Reserve Chairman Paul Volcker has called the price of a country's currency the most important price in its economy.

If that is the case, then the 14 percent decline in the value of the US dollar against the euro should be getting more headlines than it has been getting. On Tuesday morning, January 2, 2018, the dollar opened at $1.2065 versus the euro. Just over one year ago, it cost just under $1.0400 to purchase one euro.

And, this decline took place while the US stock market continuously reached newer historical highs throughout the year. Over the same period of time, the S&P 500 stock index rose by almost 20 percent.

What caused this slide in the value of the dollar?

Ira Iosebashvili writes in the Wall Street Journal that the "Dollar Could Get a Lift From Tax Overhaul."

"Some investors are betting the dollar's nearly seven-year bull market is due for one last hurrah in 2018."

"The view hinges on a sweeping overhaul Congress passed in December."

The tax plan could make the economy grow faster; cause the Federal Reserve to raise interest rates faster than they planned; and generate a repatriation of corporate cash held overseas.

But, even though this "bump" could take place, these individuals believe that the strength will only last for six months or so. The dollar strength will only be short-lived.

The reason for this is the strengthening of European economies and the fact that the European Central Bank will begin to tighten up and begin to push European interest rates higher. And, since the growth in the economies of the eurozone is lagging substantially behind the growth of the United States economy, now over 8 ½ years into its current recovery, Europe "has much more room to expand than the US."

In other words, the European economies will be stronger than the US economy this year, and the ECB will have more room to raise rates relative to the United States.

Mr. Iosebashvili writes that Bank of America Merrill Lynch has even predicted that the dollar price of the euro will drop to $1.10 in the first quarter of 2018, but then will rebound after that.

But the whole story rests upon how strong and productive the US economy will be in the near future versus the economies of the eurozone.

In this case, the longer run bet of investors seems to run in favor of the Europeans. Even with the rise in the populist elements of the European electorate, one gets the feeling that the two largest economies in the European Union, Germany, and France, will lead the continent into the future.

Ms. Merkel, the Chancellor of Germany, and Mr. Macron, the President of France, will pull things together and lead the rest of the EU into a new found unity and reform.

The sentiment in world markets seems to be that the European Union will be on the rise relative to a United States that is primarily looking internally. The bet is for a stronger, more productive European Union versus a retreating United States.

The concern over the longer term weakness in the United States economy seems to be picked up in the fact that the yield curve in the United States is the flattest it has been in a very long time.

Last Friday, the interest rate spread between the 30-year US Treasury bond and the two-year US Treasury note was only 85 basis points, and the spread between the 10-year US Treasury note and the two-year Treasury note was only about 50 basis points.

Even with the passage of the tax bill in Congress, investors are currently seeing very little pick-up in economic growth or in US inflation. And, with three more increases in the Fed's short-term policy rate coming this year, there is a real possibility that the yield curve could turn negative.

This is not a good economic sign.

The market assessment: the economies of the eurozone have stronger economic possibilities in the near future than does the US economy.

Furthermore, the current position of the US government on trade relations does little or nothing to help this assessment.

There may be a first quarter, or, a first quarter and second quarter, rebound in the value of the US dollar, but it seems to me that the longer-run view of the dollar's value is toward greater weakness.

And, this belief is based on the fact that European productivity is going to be on the rise in the near future whereas the productivity of the United States is going to remain relatively flat.

In such an environment, the euro stands to gain against the US dollar.

Furthermore, I don't see anything on the horizon that indicates the US government is anxious to move toward policies that will raise US productivity and return the United States to a more competitive position.

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.

About this article:

Expand
Author payment: Seeking Alpha pays for exclusive articles. Payment calculations are based on a combination of coverage area, popularity and quality.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here