The unexpected weakness that has plagued the US dollar in 2017 is set to reverse in the coming few months as long absent inflationary pressures begin to emerge in the world’s biggest economy, State Street Global Advisors’ global head of currency management says.
That turning trend in the so-called “big dollar”, combined with a deteriorating Australian terms of trade, should drive an “overvalued” Aussie lower by around 3-5 per cent over the next six months or so, the Boston-based Collin Crownover believes. After shooting above US81¢ three weeks ago, the Aussie has dropped around US3¢ to now trade at around US78.2¢. Crownover’s estimate suggests a further US4¢ fall ahead.
At the end of last year most forecasters had the greenback pushing firmly higher this year. Instead the Bloomberg US dollar index, which is a trade-weighted measure, has dropped 8.2 per cent over the past nine months. Analysts blame unexpected strength in the European economy driving the common currency higher at the expense of the dollar, as well as US president Donald Trump’s failure to follow through on promised expansionary policy measures.
But with the greenback staging a recovery in recent weeks, currency strategists are now dusting off their arguments in support of strong US dollar recovery from here and into 2018.
“I think we are very likely to see the [US] dollar rally reasonably significantly over the next quarter or two,” Crownover says.
The US dollar strength will naturally come at the expense of the Aussie currency. And the forecast of a weakening trend in the local currency comes despite Crownover seeing the potential for a rate hike by the Reserve Bank of Australia as soon as early next year.
“I do think the economic data is getting good enough in Australia that a Q1 2018 hike by the RBA may be on the cards. If that’s the case it may help limit the depreciation [in the currency], but we still think that the RBA is not going to be hiking at the same speed as other central banks such as the Fed and the Bank of Canada.”
Indeed, Crownover says “unless there is some economic catastrophe in the US, the Fed is going to go [lift rates] in December. Beyond that, traders are only pricing in one more rate move by the Fed next year – a stance that Crownover struggles to understand.
“I think the market is severely underpricing likely tightening in the US,” he says.
Crownover believes that the long-absent price pressures will begin to emerge before year’s end and add credence to the Fed’s stated position of more like three rate hikes in 2018.
He points to State Street analysis of online prices, which he believes is “more timely and thorough” than the official numbers and which shows inflation running at 2.5 per cent year-on-year, against the most recent official reading of 1.9 per cent. And the online price inflation has been accelerating.
This will likely translate into higher than expected official inflation numbers “over the next few months”, which will “give the Fed air cover to hike at a fairly regular but not aggressive clip,” Crownover says.
“That will lead to the Fed tightening faster than other major economies, and while there are periods where relative yields don’t drive currencies, over the medium term they almost always do,” he says.
Investors also seem to be positioned heavily towards a weaker greenback, suggesting a trade that may have extended as far as it can and so is liable to a short term correction the other way. Short positions in the US dollar futures markets are at a five-year high, Crownover points out, “so the market is very slanted”.
Long delayed US legislation aimed to bring home the trillions of dollars held overseas by US companies will be enacted in early 2018, providing a further fillip to the greenback, Crownover says.
“We do think there is going to be another Homeland Investment Act in the US,” he says, referring to legislation that gives a tax break to businesses repatriating their overseas cash hoards. A similar piece of legislation in 2005 brought a “quite substantial” amount of money back to the US, Crownover says.
“It didn’t seem to have the effect on the real economy that everyone had hoped, but it did have a strong effect on the US dollar which had been declining in 2003 and 200; you saw a 10 per cent gain in trade-weighted terms in 2005 mostly due to that tax amnesty repatriation.”
Finally, while he wouldn’t be “completely shocked” if current Fed chair Janet Yellen’s term was extended beyond February, “it looks like we are starting to coalesce around Kevin Warsh as the likely replacement,” he says.
“The good news is [Warsh] is a former Fed governor who believes in Fed independence,” Crownover notes.
“At the very least would continue on with the hiking cycle and in fact might accelerate it because he has valid concerns about how low interest rates have created this pile of debt that we see globally. That may not be an imminent problem, but as we’ve seen through history, when you have large stockpiles of debt that have increased quite rapidly on inflated asset valuations, that doesn’t usually spell good things for the real economy in upcoming years.”