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What Will Reverse The USD Downtrend?

I asked this same question about a year ago, when the USD was in similar doldrums. The answer remains the same, and deserves a review.

  1. Improving US economic fundamentals or rising short term interest rates (or prospects of them) relative to those of other major currencies. Possible but the least likely.

 

  1. A strong increase in risk aversion. A matter of when, not if. The secular bear market in stocks and most risk assets from subdued growth is likely to remain in place due to:
    1. Long term weakness in US the pillars of US economic fundamentals, jobs, consumer spending, housing, as the US deleverages
    2. Austerity spending takes hold in Europe, the UK, and ultimately Japan and the US
    3. Given the lack of transparency of Chinese data, significant negative surprises on China cannot be ruled out
    4. The next blowup in the EU banking/sovereign debt crisis. A matter of when, not if, once again. This can be deferred as long as EU leaders remain willing to buy dubious PIIGS bonds, but the credit-worthiness of these nations is not improving, nor is that of the relatively healthy nations and banks that are buying these bonds and thus becoming more vulnerable to the eventual default/restructure

 

  1. Any other EUR specific weakness. Because the volume of trade in the EURUSD pair is about a third of all forex trade, the two currencies force each other to move in opposite directions like children on a seesaw. Past attempts at common currencies without common, centralized budgets have failed, and the EU is not doing well in its first real economic downturn. However loss of national control over budgets means loss of sovereignty, and no one in the EZ appears ready for that. Thus the EUR as we know it is unlikely to survive the coming years.

 

There are other possibilities

Recent history suggests that the first 2 scenarios, a spike in risk aversion or EUR specific weakness, will spark the next USD rally. New trouble in the EU banking/sovereign debt crisis, which combines both scenarios, remains the most likely specific scenario given the ongoing failure of the EU to restore real creditworthiness to the weakest members and enact credible controls to maintain fiscal order among its members. We don’t see that happening.

Disclosure: No Positions