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USD SHORT TERM UP, LONG TERM DOWN BUT HARDLY OUT



Excellent article and comments.

 

Despite the justified talk about the USD losing its 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.

USD due for 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, then 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. 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 # 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.

 

In sum, 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.