Why the dollar continues to fall despite the US retaining a yield advantage?

Why the dollar continues to fall despite the US retaining a yield advantage?

Today may be the first time in a long time that payrolls fails to move the FX market, for the simple reason that the data is pre-virus panic. As noted above, payrolls going negative is not a silly idea—it has happened twice in the past 20 years.

One important question is why the dollar continues to fall despite the US retaining a yield advantage, however narrow it gets by end-April. Remember, the current CME FedWatch shows nobody expecting rates the same by then and a majority sees rates at zero to 0.25%, or down another 1%.

Answer No. 1 is that carry trades are still being unwound and the flight to US bonds is being done by domestic American investors or foreigners not bothering to hedge (e.g., Japan). It’s not the absolute numerical differential, but rather the trajectory, and that’s still moving down. Doesn’t this have to come to an end at some point? Well, no. Not until the tide of sentiment turns, and that’s not likely until the coronavirus crisis is thought to be ending.

Then there’s plain old-fashioned positioning. The world was already vastly long dollars. The dollar was overbought by any measure. When the Big Bank and other traders with deep pockets decide to stop selling is a slippery thing. Sometimes they punch the rest of us in the face with a short squeeze, just because they can. Big bank positioning can be independent of the news, and sometimes it’s hard to find a rationale on the chart, either. This is as big a known unknown as any other.

That’s another answer: the dollar stops falling when economic recovery seems likely. You can’t get a recovery until you’ve reached rock-bottom. How will we know where rock bottom is? Think back to those awful Chinese PMI’s, down in the 20’s. Some preliminary data indicate activity in China may already be on the way back up. A V-shaped recovery in Chinese PMI’s would be impeded by slowdown elsewhere, so it gets tricky saying when China will have reached rock-bottom. But if China is a model, first we get a giant crash in US and European PMI’s, followed by a rapid recovery. 

China reported today that outside the city of Wuhan, the Hubei province has no new cases. The graphs show cases tapering off. From the announcement at end-December of the coronavirus to today, that’s about ten weeks. Of course, China was remiss in not reporting immediately, but even if we add another month, we are still talking weeks, not months and years. Here’s the problem—China was able to impose strict quarantine on tens of millions of citizens. Nobody else can do that.

A third answer is that cases never reach a high proportion in the West and then in addition start tapering off. It’s not totally out of the question that we have had the coronavirus all along and it failed to catch fire, or that US and Western European citizens are just so much healthier than the Chinese that it is more like a common cold than a super-scary and high-mortality disease. This is not to underplay the danger or to embrace the Trumpian view, but to focus exclusively on the worst-case scenarios, as the financial markets are doing, is not entirely reasonable. Somewhere in a back room, smart traders are plotting where and what and how to buy. Mini-recoveries are highly likely, so that when the real recovery comes, we will all be asking whether the boy cried wolf when it was only a poodle.

What’s next? The UK and BoE appear to be coordinating monetary and fiscal policy in response to the crisis, and it’s the only country that is openly doing that. What a surprise—good management from the Boris team. We await the ECB next week but of course it has almost no wiggle room in monetary policy and great dissention on fiscal opportunities. As for the US, the White House claims it’s doing as much as anyone can expect and this is not a big deal, anyway, a stance that is deeply dollar-negative.

Politics: We have 261 days before the general election in November.

The new Democratic party mantra “Just not Bernie” got a little louder yesterday when Elizabeth Warren gave up her campaign (probably the best organized campaign of all time). She has yet to announce whether she is throwing in with Bernie or Joe. We were not all that crazy about Warren’s self-righteousness and whiny voice, but her policy ideas were (mostly) sound and she had a plan for (mostly) everything. Up against a president who never plans at all and shoots from his hip without ever reading or taking expert briefings, Warren looked pretty good. And that may have been part of her lack of popularity—it’s one thing to be more competent than everyone else, but showing it off looks like oneupmanship and condescension.

Warren and Buttigieg were the two smartest people on the stage as well as the two best-organized. Biden is probably one of the least smart and his campaign is a sloppy mess. But Reagan was not a bright bulb either, and made up for it with decades of study and a flair for making buddies (like Margaret Thatcher). There a fair amount of hand-wringing that it’s two ancient white dudes--no women made it to the nomination. Yeah, but we would not be surprised to see Warren or Kamala Harris selected for VP, with Warren’s filing cabinet of plans a decided advantage and Harris’s feistiness and brownness an advantage, too. 

 

Source : FxStreet by Barbara Rockefeller

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