Our Dollar, Your Problem?

01/29/2018 10:31 am EST

Focus: CURRENCIES

Robert Savage

Partner & CEO, CCTrack Solutions

Inflation is showing up in commodities and that makes for trouble as the rest of the world needs to hike rates faster or have a stronger currency. The tradeoff between forex and rates is under scrutiny, writes Bob Savage, CEO of Track Research Friday.

Illusions of control start every day as we end our sleep and dreams and believe to be awake and thinking.

That illusion extends to politicians as they believe in the global coordinated growth recovery and think that policy can remain unchanged even as economies arise from their slumber.

Forex rates are rejecting the dream state where the U.S. dollar (USD/EUR) gains over the last 4 of 5 years helped support the recovery even as the U.S. FOMC tapered then tightened policy hitting U.S. growth but helping the rest of the world. This brought about a turn in U.S. politics and Trump speaking at Davos Friday  about “America First.”

The need for a fair deal on the U.S. situation was highlighted Thursday by the IMF and ECB charging Mnuchin with breaking the “strong dollar” promise, but expecting even more from the FOMC over the year. The FOMC faces a shift in the markets opinion about its policy normalization as the pace of 2-3 hikes in 2018 is no longer considered optimistic but the floor given the USD weakness, the U.S. deficits and the risks to inflation as excess capacity everywhere disappears.

Inflation for the first time in years is showing up in commodities and that makes for trouble as the rest of the world needs to hike rates faster or have a stronger currency. The tradeoff between forex and rates is under scrutiny as the correlation has broken down in the first 28 days of 2018.

For Europe, the EUR gains are a problem as the deal for the periphery is either the bond spreads collapse to near Bunds or the currency remains weak to allow for a normalization of business across the EU. If the EUR rally extends to 1.30 the recovery in Italy, Spain, Portugal and Greece will be in doubt and the ECB will have to remain easier longer.

The problem is the divide in the ECB seems wide – witness the Reuters report Friday morning. Also, ECB Coeure spoke in Davos and was quite hawkish saying that the ECB will have to focus more on the upside risks going forward and that "forward guidance will have to evolve, we are in talks." This was the problem for the FOMC over the last 4 years and now the world is seeing the payback.

It’s a fair deal if you think the U.S. is closer to a recession than to an extended recovery. There is the rub and the start for understanding Trump’s next speech and the rough draft of his State of the Union. 

Our dollar, your problem?

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