US dollar bears in 'hibernation' for now

Bearish sentiment on the US dollar appears to have gone in hibernation for now, but may surface later down the year, according to a leading City analyst. 

In a note to clients, Kit Juckes, Head of FX at Société Générale, said the December US trade deficit, at almost $60bn, raised plenty of eyebrows overnight and was much more worrying than the ADP employment survey. 

“For President Donald Trump, who likes to look at bilateral balances, nearly two thirds of the deficit is with China and there are $5bn-plus deficits with Mexico, Japan and Germany too. The only G7 economy with which the US still has a surplus is the UK,” Juckes noted.

“More broadly, and more importantly, US imports are growing steadily at 3.1% year-on-year, but exports are running at 0.1% year-on-year not, mostly because the rest of the world is slowing and partly because the dollar is, in real trade-weighted terms, very strong.” 

But does that matter for the currency? “Not now, certainly not today but eventually, of course it does. The dollar rose in 2018 on economic outperformance, reaching the levels of 2017 and 2002, and that is having economic consequences. When the US economic downturn establishes itself, the dollar will weaken. And the question will remain - against what?”

Waiting for the overvalued dollar to reverse course requires patience, Juckes said and is itself one driver of the lack of foreign exchange volatility. 

“That patience is being tested even more by an inbox filling with a growing number of papers arguing for, and against, Modern Monetary Theory. This very American theory promotes the idea of using fiscal policy as the main tool for cyclical economic management (pushing monetary policy firmly into second place), and argues that since the US government can't default on its debt, it should be willing to spend until the output gap is closed and the economy returned to full employment, which will also be the point where the spending is inflationary.” 

The extent to which spending should be financed by issuing money, or by issuing debt, should also be a function of what is needed to control inflation, rather than some outdated concept about the dangers of expanding the amount of money in circulation. 

There are plenty of orthodox economists throwing their arms up in the air in disgust at the whole idea, and there will be plenty of proponents disgusted by an attempt at a one-paragraph summary, but Juckes noted that what strikes him about the whole idea, and the debate, is that at its heart, it is only really possible to see the world this way if you're blessed either with a truly outrageous current account surplus (and probably, some pretty impressive capital controls), or if you enjoy the exorbitant privilege of controlling the world's reserve currency. Which, of course, the US does. 

“The only reason the US can't default, is that it can print as many dollars as it likes and be sure to find holders, at a price. In the end, that price involves a weaker dollar but not nearly as weak a currency as the UK, say, would get if it went down the same path,” the SocGen analyst added.

Does the debate matter? Maybe not, but it has modern echoes of the debate about an overvalued dollar that stemmed from US economic outperformance and fiscal extravagance before Plaza in 1985. 

“The dollar isn't nearly as strong now as then, but the Powell Fed isn't the Volcker Fed, either. The end result, with trade concerns and a desire for more growth, will be a weaker dollar. Just not quite yet,” Juckes concluded.