The Daily Prophet: Things Just Got a Lot Worse for the Dollar

Connecting the dots in global markets.

To get a sense of how surprising the dollar's decline has been this year consider that at the start of 2017 none of the 28 strategists surveyed by Bloomberg were forecasting the U.S. Dollar Index to be trading as low it is now. At the time, the median third-quarter estimate for the index was 100.1, higher than the current level of 92.233 in late trading Wednesday.

The reasons for the dollar's depreciation are well-known, ranging from the dysfunction in Washington to the unexpectedly low rate of inflation. But even after the Dollar Index's almost 10 percent drop this year, things aren't looking any better for the bulls. The latest hit came Wednesday with news that Federal Reserve Vice Chairman Stanley Fischer has resigned effective mid-October. The reason that's important for currency traders is that Fischer spent a lot of time defending traditional economic models that suggest inflation should accelerate as the unemployment rate drops, which is why the Fed has had a hawkish bias of late. But without the likes of Fischer and Chair Janet Yellen, whose term ends in February, the Fed is likely to lean more dovish, according to FTN Financial economist Chris Low.

Without the prospect for higher rates, there's little incentive to buy the dollar. That explains why the greenback has been so weak of late even though geopolitical risks have risen. According to the foreign-exchange strategists at Morgan Stanley, the dollar is no longer acting like a haven. Instead, it's tracking Treasury yields, which have fallen. Based on its models, the dollar is more sensitive to moves in  bonds than at any time since at least the late 1990s. It's telling that the Bloomberg Dollar Spot Index failed to end the day higher even after the news that President Donald Trump sided with Democrats on adding a three-month extension of the U.S. debt limit and government spending to a hurricane-relief bill.

STOCKS DODGE ONE BULLET WITH MORE TO COME
The interim debt-limit fix and aid for Harvey gave investors the first real sign that maybe Washington isn't so dysfunctional after all, and that Republicans and Democrats can work together. The news certainly gave stocks a jolt, with the S&P 500 Index reaching its highs of the day. Bank of America Merrill Lynch, for one, thinks investors should be more confident on equities. The firm said in a research note Wednesday that it recommends being bullish given that the first synchronized upswing in the global economy since 2007 is a strong tailwind for earnings. By its reckoning, the firm figures that global corporate profits are running 13.5 percent higher than  last year. That's in line with the gain in the benchmark MSCI All-World Country Index, suggesting stock prices have not gotten ahead of themselves. To be sure, there are plenty of other issues on the horizon to worry about, including the potential drag on the U.S. economy from Hurricane Harvey and possibly Hurricane Irma, the U.S. debt ceiling issue only being pushed back to December and central banks talking about pulling back from their extraordinary stimulus measures.



BOND TRADERS WATCH THE CAN GET KICKED DOWN THE ROAD
The debt ceiling agreement certainly caught most -- but not all -- bond traders by surprise. While U.S. Treasuries sold off on the news, one group of traders is sitting pretty. Debt ceiling jitters were particularly high Tuesday when the Treasury Department auctioned $20 billion of one-month bills at a rate of 1.30 percent, which was higher than the 1.23 percent yield on two-year Treasury notes. Those who were brave enough to buy at those rates saw the value of the bills soar Wednesday as the rate dropped to 1.02 percent. That's a historic move for four-week bills, considered the safest investment on the planet. Alas, the debt ceiling agreement only pushes back the day of reckoning from early October to sometime in December. As a result, rates on bills maturing in the middle of that month jumped. “This just kicks the can down the road,” Jefferies economist Thomas Simons told Bloomberg News' Alexandra Harris.


CANADA WON'T BE IGNORED

It's possible the biggest surprise of the day in markets wasn't the unexpected debt ceiling agreement, but rather the Bank of Canada's decision to raise interest rates about a month sooner than expected. The move sent Canada's dollar soaring by 1.2 percent to a two-year high and pushed up local bond yields. Policy makers raised their benchmark rate 25 basis points, to 1 percent, the second increase since July. Governor Stephen Poloz is trying to strike a balance between bringing rates back to more normal levels amid the strongest growth spurt in more than a decade, and avoid harming an economy that is only now beginning to fully recover from an almost decade-long downturn, according to Bloomberg News' Theophilos Argitis. Wells Fargo expects the loonie's rally to continue. After the rate increase, the firm sent out a research note saying that it sees the currency strengthening to $1.16 in 12 months and to $1.12 in 18 months, from $1.2231 Wednesday.


WEATHER ‘TRIFECTA’ PUNISHES NATURAL GAS

The weather is doing no favors for U.S. natural gas bulls, according to Bloomberg News' Ryan Collins. Cooler temperatures are set to spread across parts of the U.S. over the next few days, eating into demand for the power-plant fuel. Irma, which strengthened into a Category 5 hurricane Tuesday, may prolong that while also threatening to wipe out power service -- and gas demand -- in Florida later this week. And based on current models, it’ll probably spare the Gulf of Mexico, where gas drillers are recovering from Hurricane Harvey.  “Now you have no direct impact on Gulf of Mexico production, and you have a large swath of Florida offline potentially” because of Irma, said John Kilduff, a partner at Again Capital LLC in New York. Add the demand loss from cooler temperatures in the eastern U.S., and “it’s kind of like a trifecta,” he said.  Despite record gas exports, a supply glut that’s persisted for most of the past two years has failed to disappear. The market is already headed into a season when demand typically weakens because of milder weather, so the surplus may expand even further. 



TEA LEAVES
The central bank-a-thon that is September continues Thursday when the European Central Bank announces its decision on monetary policy. While no one expects a shock like the one delivered by the Bank of Canada on Wednesday, that doesn't mean you shouldn't pay close attention. According to the economists at Bloomberg Intelligence, ECB President Mario Draghi faces a delicate balancing act: how to react to a rapidly recovering economy with no signs of inflation. Based on their assessment, Draghi is probably counting on faster price increases to eventually materialize, but uncertainty about when that will actually happen will cause him to move cautiously on removing stimulus and ending the ECB's bond purchase program.

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