Amid all the chaos of the past 2 years, one of the world’s single most important financial feature has remained extremely stable.

The U.S. dollar, linchpin of the financial system is startlingly calm. Using the US dollar Index DXY measure of the dollar against its major developed and emerging trading partners, it is trading very precisely at the average of the past 50 years. since it abandoned any link to Gold in 1971

It is also trading almost exactly where it was when Donald Trump was elected president and it is sitting exactly on its average price for the last 200 days.

The key question is whether this is about to end ?

Where the US dollar goes next however will matter a lot for the financial market and our take is that we have made a secular top in the value of the US dollar and that a secular decline may be starting soon.

If the currency is cheaper, the U.S. would benefit from greater export competitiveness, and many countries would find their surfeit of dollar-denominated debt easier to finance. A lower dollar will be positive for emerging markets equities, debt and currencies and will ease the debt burden of emerging economies that tend to borrow in the Greenback.

A weaker US currency is also potentially inflationary for the US economy and there is a clear inverse correlation between Gold and the US dollar as the following chart shows.

The US dollar also tends to be sensitive to the risk appetite of investors, particularly when one looks at the JPY/USD pair. At times of optimism the Dollar would rise and the Japanese yen depreciate and at times of pessimism or market volatility, the Japanese Yen tends to rise against the US dollar, although this is a short term phenomenon.

This is probably because for years the low nominal rates and persistent deflation in Japan has made the Yen the currency of choice to leverage positions in the financial markets

The concept of REER or Real Effective Exchange Rate for the dollar, taking into account how the currency has moved compared to how it would need to adjust to account for different inflation rates in different countries, shows that the dollar is overvalued according to Bank of America Merrill Lynch.

However, this indicator is not very relevant in the short term and the period used to measure the inflation rates may change drastically the conclusions.

A more interesting indicator is the trend in interest rates and in particular real interest rates.

If, for instance, The FED lower rates while European rates stay stable, the US dollar will tend to depreciate particularly if real interest rates are the same. However, in periods where real interest rates are sharply negative in Europe and only marginally negative or even positive in the US thane the US dollar will tend to appreciate as money naturally flows towards to highest real interest rate.

Equally, if the GDP growth of America is slowing down and the GDP growthof Europe for instance is stable or rising, then the US Dollar would tend to depreciate as investors would anticipate lower US rates ahead.

We are exactly at this juncture and the release of the US 3rd Quarter GDP today should give an important clue as too where the US dollar is heading.

The following chart is the Atlanta Fed’s GDPNow forecast, which aims to capture the economy in real time and it shows a 2 % growth rate.

Others calculations show different results.. The most recent estimate from Bank of New York  Mellon Corp. shows a sharper slowing to 1.5%

The consensus number is for a GDP growth of 1.6 % in Q3 2019. If the number comes out lower, then the Dollar could depreciate.

Another important element for the US Dollar will be the widely expected decision by the FED to lower interest rates by 0.25 %.

According to Bloomberg, the market puts the odds of a cut in the fed funds rate at 89.9%.
To leave rates unchanged at this stage would be a major shock. Our take is that the inflation numbers and the strengthen in the stock market do NOT justify a rate cut but the market rationale is that Jerome Powell is still in his “insurance” policy against a negative outcome oil the Trade war negotiations.

There will be a press conference from Jerome Powell and the market will scrutinise his words for more rate cuts ahead.

However, more rate cuts would actually mean a full easing cycle and not simply an insurance policy and this is normally seen only just before recessions. As Joe LaVorgna, U.S. economist at Natixis SA points out, the fed funds rate is still above the two-year Treasury yield. This is unusual, and is close to levels that would imply a recession, so there will be pressure to signal future rate cuts.

As described above, given the extraordinarily low and negative rates available elsewhere, a U.S. cut may not be enough to stop the logic of the positive carry that leads people to park their money in dollars, as this chart from NatWest Markets shows:

As the above chart shows, the phase of appreciation of the US dollar that we correctly timed in 2014 is ending and the carry trade advantage is slowly but surely diminishing. Europe’s economy is likely to be on the med while we see the US economy slowing down much faster in the coming months.

If one is to believe the behaviour of bond markets in August, a recession is at hand and that may not be discounted in the value of the US currency.

A clear message from Powell that the Fed doesn’t intend to raise rates in December would lead some to fear a mistake, which could damage the economy and increase risk. The dollar will rise again if Powell attempts to hold the line against further rises.

A more significant driver of US dollar move could be the U.S. employment data to be released on November 1. The unemployment rate is historically low, while risks that this will lead to inflation seem minimally low. The market remains so strong that it seems absurd to fear a recession.

However, when the unemployment rate turns and begins to increase, even when still at a low level, that is a strong indicator of a forthcoming recession.

When the three-month rolling average rises sharply above its low, we should brace for a recession. There is no need to do so yet. However, the recent trend in earnings growth suggests the employment market is weakening.

Finally, a resolution – even partial – of the US -China Trade War will be definitely US dollar Bearish as a major component of the agreement,ent will be a currency pact as there is not much ore that the parties can agree upon.

As they need an agreement, China will probably accept to commit to let its currency appreciate gradually over the coming years against the US Dollar.

But to us the main problem does not lie there.

A our readers know, we are extremely worried by the state of leverage of the US economy, the overhyped stock markets and the countercyclical impact of the Trump tax cuts on America’s public finances.

The US economy is highly dependent on its consumer and the US consumer is highly leveraged and because he is highly leveraged, he is highly sensitive to the performance of his 401-K retirement plan and to the valuation of real estate.

Unfortunately, both are at extremes of valuations.

Equities have been boosted to abnormal valuations by the combination of extremely low nominal interest rates, and the madness of CEOS who are buying back massive amounts of their stocks at rates of return on investment way BELOW the ones they achieve in their businesses.


Real estate prices are now way above their previous peak of 2006 according to the Case-Shiller Home Price Index and affordability is becoming a problem.

At the same time , U.S. household debt has been rising to $13.86 trillion in the second quarter of 2019, according to data from the New York Federal Reserve, marking the 20th quarter in a row where debt balances increased.

In the second quarter, debt increased by $192 billion – up 1.4 percent – and it’s now higher than the previous peak before the financial crisis.

If, as we expect, employment starts to soften, equity markets turn and real estate prices start turning as well, then the multiplier effect on consumption could be drastic, sending the US economy into another 2008 type of financial and debt.

Add to that the fact that the State is also highly leveraged and has just reported a 4.6 % Budget deficit at the peak of an economic cycle, the next economic downturn will send the budget deficit soaring, bond yields jumping and everybody scrambling to get fianancing at a time where the credit perception of the US is deteriorating.

This factors are all EXTREMELY negative factors for the US dollar and they may even lead ventral banks in China and Japan to reduce their massive holdings of US Treasuries.

Unfortunately, for us, the problem is not really IF the above scenario will unfold but really WHEN it will start.

We may see a year-end rally in global assets, surely, but beyond the end of the year, we would remain extremely cautious.