Bloomberg’s Cudmore Stands By His Call: “The Dollar Is In A Multi-Year Down Trend”

This week on Erik Townsend’s MacroVoices podcast, Bloomberg macro strategist Mark Cudmore (a frequent contributor to ZeroHedge) and Townsend discussed last week’s “lower low” in the US dollar index and what this means for the near-term future of the greenback – a trade that will have profound ramifications for financial markets.

Back in October, Cudmore projected that the rise in the US dollar still had room to run as a shift in Chinese monetary policy (keep in mind this was months before the rumors about China cutting back on purchases of US debt emerged) would cause Treasury yields to climb, dragging the US dollar higher. The dollar finished the year on an upswing, but has slumped in recent weeks, ignoring the bounce in Treasury yields.

Treasury yields finished last week at their highest levels in years, but the dollar index slipped to its weakest level since late the final days of 2014. 

Cudmore started by contrasting the consensus view heading into 2017 with the view heading into this year: Early last year, markets were dominated by the expectation that the US would lead a global reflation trade – but, as things turned out, the US wound up in the middle of the pack in terms of growth and inflation in terms of the G-10 economies.

This year, there’s been a shift: The US is still expected to be one of the fastest-growing G-10 economies this year. Yet positioning is much more bearish. Case in point: Two-year yields have gained about 70 basis points during the past four months.

And so, suddenly, that massive negative real yield you had in the US has kind of disappeared. So both the rates argument and the growth argument are much more supportive of the dollar this year than 12 months ago. And yet the kind of positioning and sentiment have switched massively.

Now I should say that this is kind of making me feel that the dollar is vulnerable to probably a sustainable bounce that could last several weeks, several months. But I think overall, structurally, in the much more longer term, I do kind of stick by my call from January of last year that the dollar is in a multi-year down trend.

And the background picture here is that the dollar still makes up roughly 63.5% of global reserves. And yet the US economy is a slowly shrinking part of the global economy. It’s currently about 24.5%.

Now, the US is the world’s reserve currency. It’s always going to retain a premium in terms of large financial markets. But that premium is going to shrink more and more. So the fact that it’s still 63.5% of reserves seems too high.

While Chinese authorities denied reports that they would scale back Treasury purchases, several European central banks, including – most notably – the German Bundesbank, said they would begin including yuan reserves for the first time. To make room on their balance sheets, they said, they would replace dollar-denominated assets with yuan-denominated assets.

Chart courtesy of Quartz

…This would support Cudmore’s long-term view that the level of dollar-denominated reserves held by the largest central banks is “too large” – one reason Cudmore sees the long-term dollar downtrend continuing.

And the background picture here is that the dollar still makes up roughly 63.5% of global reserves. And yet the US economy is a slowly shrinking part of the global economy. It’s currently about 24.5%.

Now, the US is the world’s reserve currency. It’s always going to retain a premium in terms of large financial markets. But that premium is going to shrink more and more. So the fact that it’s still 63.5% of reserves seems too high.

So I think, structurally, the world is still long dollars and will slowly start trimming that position.

And that’s going to be a headwind for the dollar. But for the next couple of months I think people are maybe over their skis and being bearish, and I think there’s a chance of a bounce.

That’s the dynamic I’m looking at, at the moment.

Asked about the possibility that the impact of rising interest rates on the dollar might be delayed, resulting in a mid-year rally for the greenback as Powell continues his predecessors’ plan to raise the Fed funds rate at least three times this year, Cudmore argued that the reality is closer to the inverse of that view.

Instead of rising interest rates having a delayed effect on the greenback, Cudmore believes currency traders were far too eager to price in rising interest rates back in 2014, when the Bloomberg Dollar Index rallied more than 25% between mid-2014 and early 2017.

So, basically, when there were only two rate hikes we saw a 25% increase in the dollar on the trade weighted index. That’s because FX markets tend to front run the expectation of the rate hiking cycle. And this rate hike cycle was very much forecast, it was expected, it was predicted.

And, in fact, it kind of came through slower than expected. So what we saw was actually the FX already made that massive appreciation. And this is why we kind of saw the dynamic last year that, even though the Euro – Europe has done very little to withdraw stimulus. They’ve done a small bit of tapering and some signaling, but still they’ve got negative yields. We’ve seen the Euro benefit. And that’s because FX markets drive it ahead.

And I think people who get very excited about the fact that there were rate hikes in 2017 and wonder why isn’t the dollar rallying – they’re not really looking at history. We generally see this in US rate hiking cycles; we quite often see that the dollar trades poorly.

The notion that the dollar would weaken during interest-rate hiking cycles actually isn’t all that counter-intuitive: When the global economy is expanding rapidly, investors in developed markets pour money into the emerging world, which generally involves selling the world’s reserve currency – the dollar.

Another factor driving the dollar’s weakness is the new yuan-denominated oil futures contract which was slated to start trading on the Shanghai Futures Exchange this week, but was recently delayed. Asked if he believes the contract will have a lasting impact on the greenback, Cudmore said its impact will likely be more nuanced, starting with the notion that the impact will be gradual: Though ultimately it will help change the narrative surrounding the dollar at the margins.

I think this is another step in the process of the dollar’s dominance of world trade, world commodity pricing, being slightly eroded at the margin.

But it’s not going to be a sudden thing. The dollar will remain the world’s reserve currency for a number of years to come. There’s just no viable alternative. It’s just that its complete share of global trading will continue to be eroded. And that’s another step in this process.

I think it is also important about how successful China manages to make this whole oil contract. And I think this may tie in with the – some people speculate this may tie in with the Saudi Aramco IPO, that maybe they can exchange some kind of support there, from Saudi Arabia for their pricing in terms of maybe investing in the IPO.

In recent months, Bill Gross has doubled down on his call that the 30-year bull market in bonds is over. DoubleLine’s Jeffrey Gundlach has made a similar argument, though the two disagree on details like timing (“Bill Gross is early”) and the location of the crucial barrier in the 10-year yield that, once breached, will trigger a correction in US equity prices.

Cudmore says he agrees that great bond bull market has ended. But having said this, Cudmore cautioned that he’s “absolutely not a bond bear.”

I think the 30-year bond bull market ended a year or so ago. I don’t think that suddenly means we need to go into a bear market. I think that – I’m absolutely not a bond bear and I think we kind of stay in this slightly volatile range for a long time to come.

And I’ll even go further and say that I don’t think the long end yields in developed, functioning societies, and developed, functioning markets are rising substantially for many years to come.

So I don’t think we’re going to see much higher yields at the back end of the curve. We can see tickups and they’ll kind of move back and forth. But, to me, there are structural disinflationary pressures which are still underestimated in the market. Particularly from technology. But also from demographics.

Townsend then moved the conversation to a painful topic for both himself and Cudmore: The rally in oil that has brought WTI futures north of $70 for the first time since 2014.

Both Townsend and Cudmore had gone on record to predict that the bounce in energy prices would be temporary – the result of worsening instability in Venezuela and certain Middle Eastern energy producers. However, the sustained rally has forced Cudmore to reevaluate his views on the energy market.

While speculative long positions have become dangerously stretched (net longs on NYMEX recently touched an all-time high), Cudmore says he only recently came around to the notion that speculators can dominate the directionality of commodity markets for long periods of time.

I thought we’d see spikes when we saw Middle East tension. I thought there would be various reasons for supply spikes. And I thought they could be very large spikes. But I thought they’d be a thing that would last for a month or so and then we’d see prices come down. Instead we’ve just seen oil continue to trend higher. And definitely this has taken me by surprise.

I think, though, that it’s not a permanent change of situation. One of the things that’s driving the markets at the moment – and I didn’t really pick up on this into December so much – is that, importantly for oil markets, speculators can actually dominate the price action for such a long period of time.

And, at the moment, we still have this backwardation in the oil curve, which means it rewards speculators for being long oil. And so a lot of people look at the market and go, oh my God, speculative positioning in oil is just completely stretched, it’s crazy, it’s due a massive correction. And people were saying this from a couple of months ago.

Yet it continues to motor higher. And that’s because, you know what, these speculators are getting paid to hold this position. So, even if it falls back a little bit, they’re not too worried. And that means it’s a very comfortable position. That will change at some point.

Over the long term, of course, oil prices will likely decline as alternatives like solar – and to a larger degree natural gas – eat into demand. 

Listen to the rest of the interview below:

Source: ZeroHedge


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