The dollar is losing its mojo at the wrong time

What’s wrong with the dollar? Barely two weeks ago the Bloomberg Dollar Spot Index reached its highest since June 2017. President Donald Trump tied the strength to confidence in the US, boasting in a tweet on August 16 that “money is pouring into our cherished DOLLAR like rarely before.” But since then the greenback dropped as much as 2.2 percent, reaching its lowest of the month before recovering to end the day slightly higher.
At a time when the US is embarking on a borrowing binge to pay for trillion-dollar federal budget deficits, any weakness in the currency should concern the government. After all, foreigners might have second thoughts about lending money to the US if they expect the dollar to depreciate. That could cause borrowing costs to rise regardless of whether the Federal Reserve raises interest rates or not. NatWest Markets strategist James McCormick has identified six primary reasons for the dollar’s recent downturn, ranging from Trump’s recent criticisms of the Fed’s tighter monetary policy to moves by China to keep its currency from getting any weaker.
But perhaps the most intriguing reason is the notion that US economic growth has peaked and will only slow. Although McCormick noted in his report dated Aug. 25 that the US economy is in good shape, a growing number of strategists are starting to point to data showing reports coming in softer than forecast.
Citigroup Inc.’s economic surprise indexes show that not only has US data largely missed estimates this month, they are missing by the greatest degree since September 2018. As such, the currency strategists at Deutsche Bank AG and Goldman Sachs Group Inc. both say they see limited upside for the dollar for now.
Benchmark 10-year US Treasury note yields closed last week at 2.81 percent, their lowest since May, amid a heated debate over whether a speech by Fed Chairman Jerome Powell — in which he said “there does not seem to be an elevated risk of overheating” — leaned dovish. But the bond market reversed swiftly this week, with yields rising to 2.88 percent. Does that mean bond traders are having second thoughts about whether Powell may be leaning toward ending interest-rate hikes sooner rather than later?
Maybe, but perhaps the better explanation is that the bears are taking advantage of the rally to set up short positions at what they think are more attractive levels. A widely followed JPMorgan Chase & Co. survey showed that bond traders are the most bearish since March. Its so-called All Client Net Long index slid to negative 21 from negative 17 in the week ended August 21. The economists at Goldman Sachs Group Inc. emboldened the bears by reiterating their call that that the Fed will boost rates two more times this year and four times in 2019. In a report, the Goldman economists emphasised Powell’s nod to a recent Fed study that indicated it would be ill-advised for the central bank to ignore low unemployment and slow the pace of rate hikes, Bloomberg News’s Liz Capo McCormick reported.
One day after setting a record, the S&P 500 Index topped that by posting yet another high. The benchmark closed at 2,897.52, putting it less than 2 percent away from the 2,950 median year-end estimate of 25 strategists surveyed by Bloomberg News at midyear. But rather than
recommending investors get defensive, get ready for strategists to get even more bullish and start boosting their year-end estimates as soon as they get back from their summer vacations — if they haven’t done so already. DataTrek Research co-founder Nicholas Colas nicely summed up the general sentiment towards stocks in a note to clients.
“As long as you believe the US economy is in decent shape (we do) and trade/tariff wars will not push the global economy into a recession (we don’t), US stocks are reasonably valued because earnings are strong/rising and interest rates remain low,” Colas wrote, referring in that last point to the 10-year Treasury note yield’s seeming inability to rise above 3 percent. At about 18 times estimated earnings, the S&P 500 is cheaper now than it was back in January, when the ratio reached almost 19 times, despite the rally in equities. That’s largely due to strong earnings growth. Colas figures the best-case scenario is for the S&P 500 to advance an additional 8.7 percent by the end of the year.
It’s getting ugly in Brazil, where global investors are revolting against the nation’s increasingly unstable political environment. Brazil’s real fell to its weakest level since January 2016. It has lost about 9 percent of its value this month, compared with a more modest 1.40 percent decline in the MSCI EM Currency Index. The nation’s equities are also down for the month and the cost to protect against losses in Brazil’s bonds with credit-default swaps has jumped to the highest since the end of 2016.

— Bloomberg

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis