Will the greenback become stronger? - March 04, 2018

Will the greenback become stronger?

There are some interesting market actions nowadays. We have seen surging government bond yields, rushing stock prices (mostly in 2017 and early 2018) and a falling US Dollar. This kind of market coincidence generally leads to stock market corrections which already happened in the past weeks. However, the question is if we will see another leg down on the stock markets and how the greenback will react.

What’s sure is that the US economy is strong. Unemployment is near all-time lows, corporate profits are rising, real estate prices are back at their highs and consumer spending is in a good shape. The Federal Reserve’s funds rate has been climbing since the end of 2015. This year, the market expects 3-4 rate hikes. Despite these factors, however, the US Dollar is unable to rise; what’s more, it has been weakening over the past quarters.

This phenomenon comes from several factors. Trump’s tax cut is a big fiscal stimulus for the US’ economy which is already in the stage of overheat. To fulfil this stimulus, the government also needs to issue more bonds with higher yields to attract investors. However, investors are already expecting deteriorating fiscal balance and higher FED funds rate, so they don’t rush to buy the bonds.

The rising US’ twin deficit (sum of the current account deficit and fiscal or federal budget deficit as shares of GDP) is another negative factor for the USD. Movements of the twin deficit normally precede changes of the USD by 1-2 years and then they move together again. The US’ twin deficit has been deteriorating for the past two years and things are probably going from bad to worse further from 2018 due to the fiscal expansions and the higher debt payment.

This can easily lead to a political problem and economic imbalance that won’t help the dollar. As we can see in the chart below, when federal deficit rises, dollar weakens and vice versa. Higher bond yields can also cause more stock market corrections before the new upleg.

Click on the image to see it in full resolution

But when this new uptrend emerges, the USD will start to grow.  For now, though, the rising global growth and weak dollar boosts commodity prices and emerging markets. Therefore, money is still looking for its ways to be invested. Besides, inflation can emerge worldwide and that will put central banks under pressure to stop monetary stimulus programs and start hiking interest rates. That would be the healthy way of economies and markets after zero rate policy.

Disclaimer: This analysis is for general information and is not a recommendation to sell or buy any instrument. Since every investment holds some risk, our main business policy is based on diversification to minimize threats and maximize profits. Innovative Securities’ Profit Max has a diversified portfolio, which contains liquid instruments. This way, our clients can maintain liquidity, while achieving their personal investment goals on the long term.