The key risk-on and off drivers today are the same – U.S. politics, global growth, other centr...
Global Chaos Good for the Dollar
03/17/2014 9:00 am EST
Geopolitical turmoil should fuel US dollar strength in the medium term, says Andy Waldock of Commodity & Derivative Advisors.
Five years ago the financial world was coming to an end. The stock market tanked and interest rates went negative due to the unsurpassed flight to safety in US Treasuries. Most of this was due to greedy lending practices that claimed to be championing President Clinton’s thesis that everyone in America should be able to own a home. Lax lending requirements that were intended to get lower-income earners into their own homes travelled up market and allowed upper-middle and upper-tier earners to refinance their houses at artificially low rates to buy second homes and Harleys. Once again, misguided bureaucratic endeavors have been perverted by greed. The roaches in China are beginning to surface and the banking system stress tests in Europe are uncovering the depth of this five-year-old issue and once again, the primary beneficiary of these actions will be the US dollar.
There are three global issues currently taking place that should combine to provide some strength to the dollar in the medium term. First, we have uncertainty in Ukraine’s standoff with Russia over the Crimean peninsula. Putin has strategically played his hand into the largest land grab since the end of WWII. Ukraine is unable to defend itself and their calls to the West for help are falling on diplomatic ears rather than military strength. The European Union can’t afford to engage Russia militarily or, economically literally, nor figuratively. They possess neither the combined funds, nor the political cohesiveness to put together a coalition support force.
Secondly, the European Union led by the European Central Bank is currently implementing stress tests on the largest European banks. Remember that these tests are in response to the economic meltdown of five years ago. These institutions, which include sovereign, public and privately held banks cannot withstand a negative rating by the European Banking Authority, which is overseeing the stress test implementation. The ECB on the other hand, cannot afford to have the European Banking Authority suggest that capital requirements should be raised due to the extremely fragile Eurozone economic recovery. In essence, it comes down to a wink and a nod behind closed doors thus rendering the entire process toothless.
Finally, China has allowed the first corporate bond default in 17 years. The Chinese economy has been the hottest of the hot for several years, now. The main Chinese points are that the Chinese debt bubble may be bursting. This default is the first but certainly not the last. Maybe not even the last for this month. The second debt-related Chinese issue is the copper they’ve taken as collateral for their lending. These first pricks of the bubble have sent copper futures to four-year lows as fear overwhelms the market based on possible copper liquidation concerns as borrowers’ loans are being called. This exacerbates itself in a downward spiral of fear similar to our housing market in ‘08-‘09.
The brief outlines I’ve given to points that will have books written about them should be enough of a cookie trail to follow the flow of funds into the US dollar. The euro, yuan, and ruble are all facing structural issues that aren’t likely to resolve themselves in the short run. There is no question that we have our own issues here in the US, but the fact is, we may just be the best house on a bad block. We’ve seen strong commercial selling of global currencies corroborated by equal strength in outright purchases of the US dollar. The US dollar Index is currently trading around 79.70. I believe the current situation could push the dollar near its heavy resistance around 81.50. Furthermore, the euro is currently trading around $1.39. This is the highest it’s been since October of 2011. I believe the euro spread against the dollar will decline at least to its trend line around $1.36.
By Andy Waldock, Founder, Commodity & Derivative Advisors
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