Tags: Fed | dollar | euro | QE

US Dollar Is King Again

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Tuesday, 04 Nov 2014 09:13 AM Current | Bio | Archive

Last week we witnessed a not-so-frequent financial milestone take place when the Federal Reserve turned off its liquidity taps that have functioned for six years under its three consecutive quantitative easing (QE) programs. The tap was turned on in November 2008 when the Fed started buying mortgage-backed securities, bank debt and Treasury notes. Then in November 2010, and after the Fed's balance sheet had reached a "continuous" amount of $2.054 trillion of assets, the Fed announced its second round of quantitative easing. Finally, in September 2012 it announced its third round of quantitative easing.

Now all three QEs have come to an end after accumulating a staggering $4.5 trillion in so-called "assets" from the end of 2008 till now.

I don't think it's an overstatement to say the Fed has taken its boldest step on its path toward monetary policy normalization that should, among a lot of other things, confirm the path of a further strengthening U.S. dollar and that is now apparently testing its 30-year post-Plaza Accord downtrend.

To refresh, the Plaza Accord was an agreement signed on Sept. 22, 1985, at the Plaza Hotel in New York between the United States, France, West Germany, Japan and the United Kingdom, which were at that time the biggest economies in the world, to depreciate the U.S. dollar by intervening in the currency markets in relation to the Japanese yen and the German deutsche mark. The Plaza Accord in fact worked out too well so that on Feb. 22, 1987, in Paris the same countries plus Canada signed the Louvre Accord to halt the continuing decline of the U.S. dollar, which had lost approximately 44 percent against the Japanese yen.

It is noteworthy after the Louvre Accord we haven't witnessed a stronger dollar coming back even though the U.S. authorities continued to state their policies aimed for a "strong dollar." On the contrary, we could say that we have witnessed a prolonged period of "benign neglect" of the value of the dollar by the U.S. authorities.

But today, I think we're are at a historical inflection point (reversal) for the path of the value of the U.S. dollar. Going forward, including for fundamental reasons, a stronger U.S. dollar is fully in the cards. If that is the case, then there are a lot of important moves underway for commodities, economies and, of course, various currencies.

I have no doubt whatsoever the global economy will have to face the formidable challenge of the effective "drain" of what was the nearly unlimited U.S. dollar-based liquidity source/pool, as it will become completely unjustifiable and uneconomical to siphon that U.S. dollar source/pool further off for buying other currencies.

It's obvious the dollar has without any doubt been the "supercharger" for the euro since mid-2001, when 1 euro exchanged for $0.85. Today it costs about $1.26 to buy 1 euro, which represents a rise in the value of the euro or decline of the dollar of approximately 45 percent.

I'd like to add that it's way too early to start talking of an overvalued U.S. dollar, as some are already doing, which doesn't mean one day the U.S. dollar won't have become too expensive. But I don't think that's up for discussion yet, and certainly not for an extended time to come.

Besides that, all investors should also keep in mind that nothing goes up or comes down in a straight line. Yes, there will be temporary reversals, and when those occur, I would start considering to buy into these "dollar dips." That doesn't mean that all is OK with the dollar, but for now at least, there is really nothing that can replace it.

For long-term investors and speculators alike, keep an eye on $1.2150 per euro. If we move through that level (that moment could be much closer than many think is possible), I think most of the stops will be annihilated and we could see a substantially lower euro, which shouldn't upset the European Central Bank (ECB) at all.

In this context, it would also be helpful to take notice of what Dallas Fed President Richard Fisher, a voting member of the Federal Open Market Committee (FOMC), said recently: "We might well move to raise rates sooner than thus far assumed, should the economy proceed along the trajectory I think we are on."

In the meantime, the FOMC continues to expect reinvesting maturing debt from its sizable portfolio until after lift-off commences, which is a position that has remained consistent during the course of the year.

For the euro, any rebound in the euro would present an opportunity to sell the single currency. At least that's my opinion, and, of course, I could be wrong.

The European Commission's autumn economic forecast projects weak economic growth for the rest of this year in the eurozone. Real eurozone GDP is expected to grow 0.8 percent in 2014, 1.1 percent in 2015 and 1.7 percent in 2016. If you ask me, that's not good at all, but that forecast wasn't unexpected news either.

That said, I still would be extremely surprised if the ECB announces a full-blown QE, which should include corporate bond buying, this coming Thursday at its Governing Council meeting in Frankfurt.

Also this week we'll have the U.S. employment situation release on Friday that should confirm, in my opinion at least, the U.S. continues to progress in a good direction. Fisher could be right about the Fed starting raising rates earlier than generally expected.

Finally, all investors would do well to remember a stronger dollar is certainly not an antidote for deflationary pressures and because of that, it's certainly not a positive for gold, as we already have seen recently. Keep in mind there is the potential for gold to move further down to the $950 to $1,100 per ounce zone. Once we are there, I'd start considering accumulating gold further depending on the rationales that are in force at that moment in time.

Also, a stronger dollar usually does not go together with higher oil prices.

Once again, and after 30 years on the downward slope, the U.S. dollar seems to be king again.

Let's hope the dollar's kingdom isn't put into difficulties from the "inside," because from the "outside" there is nothing serious to be afraid of.

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HansParisis
Once again, and after 30 years on the downward slope, the U.S. dollar seems to be king again. Let's hope the dollar's kingdom isn't put into difficulties from the "inside," because from the "outside" there is nothing serious to be afraid of.
Fed, dollar, euro, QE
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2014-13-04
Tuesday, 04 Nov 2014 09:13 AM
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