It’s The Dollar, Stupid!
By Tyler Durden
Submitted by Paul Brodsky via Macro-Allocation.com,
We think the markets have it fundamentally wrong. US investors are anticipating a cyclical shift towards economic expansion via new tax incentives, business de-regulation and Keynesian government spending that promise to increase output, demand and asset prices. However, there is a far more influential driver of future asset prices – a structural shift that has begun but has yet to be acknowledged by economic and political authorities, and, judging by financial asset markets, by most investors. We expect weak equity markets and a strong treasury market beginning in 2017.
It’s the Dollar, Stupid.
The financial model used by advanced economies since 1971 is quickly losing its ability to support economic growth and rising asset prices.1 Western economic policy, which had previously relied heavily on credit creation from 1971 to 2008, was replaced in 2009 by monetary policy that relied heavily on base money creation through asset purchases. The structural shift in central bank focus from credit to monetary creation marked a paradigm shift in the decades-long finance-based economic model – from the leveraging phase to the de-leveraging phase.
The Fed shifted to relying on a communications policy in 2013, which focused on renewing the broad perception that by “normalizing” US interest rates the economy would again begin to react to credit incentives it could manage. It also emphasized the need for fiscal stimulus, which would ostensibly create demand and stimulate production growth. Last month the Fed hiked overnight rates for the second time in two years and the markets expect it to hike rate three times in 2017.
Fed rate hikes tighten credit conditions in the US and, given the continued execution of QE by other major global central banks, increase the exchange value of the dollar. A stronger dollar theoretically increases other economies’ exports into the US, provided that US consumers and businesses are able to maintain the same level of demand for foreign goods and services. This is an open question.
Donald Trump’s election raised hope that new tax incentives, business de-regulation and Keynesian government spending will create sufficient demand. The dollar and US financial markets have reacted in sympathy with stock prices rising and bond prices falling…despite the Fed’s renewed credit tightening. A strong dollar would tend to attract global wealth to the US, wealth that theoretically could find its way into US risk assets including US equities. Thus, US equity strength since the election reflects a strong dollar, which is based on the combination of Fed rate hikes and renewed hope for US government stimulus.
This is not the first time the Fed has had to actively increase the exchange value of the dollar. Paul Volcker’s Fed had to hike overnight rates to 20% in 1980-81 so the dollar would be reaffirmed as a store of global value for US trading partners, including OPEC. We believe the Fed is doing the same today, in spite of its de-stimulative impact, because it wants to attract global capital to US banks and asset markets. Doing so would ensure …read more
Source: It’s The Dollar, Stupid!
