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Jay Powell’s speech in Jackson Hole pretty much sealed the deal for a September rate cut. Markets cheered. Angels sang. All is well again, now that the pivot is finally materialising.
But perhaps the most noteworthy subsequent market move came in currency markets, where the dollar index on Friday slumped to its lowest level in a year. It’s clawed some of that back this week but dollar selling is likely to get a lot worse, according to Stephen Jen of Eurizon SLJ.
Morgan Stanley’s former currency supremo reckons the greenback’s recent slide may yet turn into an “avalanche” as dollar depositors with a nervous eye on America’s rising trade and budget deficits and “no loyalty” to the world’s de facto reserve currency begin to flee.
Per his latest note:
The high cash rate on USD deposits has hidden the underlying deterioration in the quality of the dollar. The twin deficits have steadily widened to alarming levels. Even though no FX strategist has mentioned the ‘twin deficits’, it does not mean they are not a huge problem for the dollar. High USD cash rate has also attracted money that is not loyal to the dollar, including Chinese exporter receipts over the years.
These huge dollar deposits held by those with no loyalty to the dollar pose an ‘avalanche’ risk for the dollar as the Fed cuts rates and as the dollar descends: the Fed could cut linearly, but the dollar’s depreciation will likely be non-linear.
Jen has been bearish on the dollar for about a year and a half, during which time it’s largely tracked sideways. “Even though I haven’t been right, I haven’t been that wrong, either,” says the former Morgan Stanley man. You can take the man out of the sellside, but not the sellside out of the man etc.
There’s something in the wind though. The dollar has already suffered the sharpest month-to-date depreciation since November last year, according to Barclays, with dollar sentiment — an amalgamation of positioning data, option skews and “proprietary work on public sentiment found in the press” — having recently turned “max short from max long”.
The latest CFTC data likewise suggests speculators are now long international FX versus the USD.
But might fears of the dollar’s demise prove overblown? As Kit Juckes at Société Générale stresses, the currency’s strength stems in large part from US exceptionalism, or the fact that “for several years, we have all been buying dollar-denominated assets”. For the dollar to keep on sliding, in other words, capital returns elsewhere need to improve.
There’s also a chance that the Fed eases monetary policy less aggressively than expected, leaving the dollar looking oversold.
Goldman Sachs analysts wrote in a note last week that “it is difficult to argue against dollar shorts a month before a cutting cycle begins,” but that the bank’s economists still expect labour market data “will be strong enough for the Fed to take a more gradual path than what is now priced”.
More structurally, we think Fed cuts are unlikely to significantly outpace global peers. Faster Fed cuts are likely to be met with faster adjustments in other jurisdictions as well, especially since activity data have disappointed: China’s growth target looks to be out of reach without more policy support, and the Euro area PMIs provided more signs that restrictive policy is weighing on activity outside of an Olympics-related boost for the French service sector.
Since we also do not think the Fed will have to use all its available policy space to ensure a soft landing, this should leave US assets still relatively attractive even if the short-term rate differential narrows a bit. This has provided the key pillar of support for the Dollar’s high valuation in recent years. And we think the approaching US election should hold back portfolio flows amidst policy uncertainty.
The US non-farm payrolls report out on September 6 is shaping up to be a big one, says JPMorgan, with markets “already bracing for volatility around the release”.