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The bullish case for the US dollar
The US dollar is expected to make a major move higher in
2012
By Matein Khalid
The world financial markets were at an inflection point on the
eve of 2012. The Eurozone debt crisis threatens a credit crunch
as banks are forced to shrink balance sheets even while fiscal
austerity rages in Ireland, Britain and the Club Med. The latest
EU fiscal discipline pact threatens a split as Britain and
Hungary vetoed any treaty change. Meanwhile, ECB President Mario
Draghi has initiated a rate cut cycle that does not augur well
for the Euro in 2012. The slowdown in China is unmistakable as
export orders decline, property prices plunge, GDP growth rates,
PMI and retail/auto sales all decelerate. As Chinese growth
falls, the Politburo shifted to a soft money bias with Premier
Wen’s “need to fine tune policy” edict and the PBOC’s subsequent
banking system reserve ration cuts.
Industrial commodities are the natural victims of a Eurozone
credit crunch and a China slowdown. This is the reason why
product premiums on aluminium, lead, nickel and copper on the
London Metal Exchange have plummeted since October. The US
economic supertanker, expected to hit an iceberg, has meanwhile
accelerated on payroll growth, with the US unemployment rate now
down to 8.6 per cent. Economics is not the only macro sword of
Damocles on the currency markets. Politics also unsettles Wall
Street. The Arab spring has led to the overthrow of four regimes
in the Middle East. Violence in Syria continues to escalate. EU
and US sanctions against Iran tighten and raise supply
shock/geopolitical risk in the crude oil markets.
As I read the macro tea leaves (or coffee beans, since we live
in the Gulf!), it is clear to me that 2012 will be the year the
US dollar makes a major move higher. Why? One, the Bernanke Fed
has no reason to ease policy any more while the ECB has begun
its rate cycle. Two, private sector deleveraging in Western
Europe has only just begun. This is negative for global
liquidity and asset volatility will creep higher. These trends
are hugely dollar positive. Three, the European banking system
faces systemic credit issues (e.g. Commerzbank, the Greek
banking system , French bank derivatives exposure) while the US
money centre banks have largely recovered from the Wall Street
Armageddon of 2008.
Four, international politics in the Middle East could well take
an ugly turn in Israel, the Gulf or Syria. This will lead to a
spike in the Chicago Volatility Index (VIX) and safe haven flows
into the US dollar. The SNB has devalued the Swiss franc’s safe
haven role with is Euro-Swiss franc FX peg. The Japanese yen is
also a dubious safe haven because the Bank of Japan intervenes
to protect Japan Inc exporters, the public sector debt is a
shocking 200 per cent of GDP and the post-Fukushima current
account surplus has shrink. Five, a credit crunch in
international interbank markets has begun. Several European
money centre banks have slashed country credit line in the GCC.
This means a rise in bank funding costs and tighter, even
sluggish loan growth. Three month dollar LIBOR rates have
doubled since July. This is an augury of a higher dollar as many
European banks, desperate for dollar funding, will be forced to
buy greenbacks in the spot FX market.
Six, the Euro will remain weak all year as the ECB abandons
monetary policy and embraces QE. The Euro, after all,
constitutes 57 per cent of the Dollar Index. Seven, as banks
retreat from cross-border trading, globalization of finance will
decline. This will make financial markets illiquid and volatile.
This means risk appetite will remain low and the VIX will remain
higher. Carry trades will be punished, particularly in the
emerging markets. Long Indian rupee trades financed by dollar
borrowing were a disaster in 2011, after all. These market
trends all suggest a higher dollar. Eight, by most valuation
metrics, the US dollar is grossly undervalued. This was not the
case in the 1970’s inflation malaise or in the late 1990’s
Silicon Valley tech bubble. Yet the dollar is now the natural
safe haven for macro stresses in global finance.
Specific strategic shorts? I believe the Australian dollar will
plummet in 2012 as the RBA slashes interest rates. Australian
households are hugely leveraged at 160 per cent debt to income
ratios at a time when property prices Down Under have begun to
drop.
Moreover, the fall in Chinese GDP demand is a disaster for
Aussie mining capex and metals exports. The Aussie/yen trade is
an accident waiting to happen as its catalysts are retail
leveraged Japanese investors, the proverbial Watanabe-san. I
believe the Aussie dollar will fall below its current 1.03
levels to 0.88 against the dollar in the first six months of
2012. Bottom fishing in emerging markets is also as dangerous as
disco dancing on minefields if King Dollar makes its big move,
as I am convinced it will in 2012.
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