Welcome to the beginning of the end of dollar strength.
I say that because of what the Federal Reserve told the world this week. As expected, the Fed removed the word “patience” from the official policy language it has been using for years to describe its approach to timing America’s first interest-rate increase in nearly a decade. But unexpectedly the Fed’s internal projections have changed. And in that change the world now sees exactly what I have been saying for months: the Fed is in an impossible position … that interest rates cannot rise very much … and because of that, the dollar’s strength has been a misguided illusion.
Now, that illusion is set to fade.
And the real message — the only message — you should take away from the Fed’s commentary is that to profit from the changes headed our way means trading in some of your U.S. stocks and replacing them with big blue-chip stocks in Europe and Asia.
It’s almost as if the Fed had a spy in the audience in my presentation in Uruguay last week.
As the world was gearing up for the Fed’s commentary this week — and the expectation of greater clarity on what most everyone expected was the coming rate increase — I was telling those gathered in South America that I believe the Fed will ultimately initiate the rate-hike cycle with an increase that could be as small as 0.1% rather than the expected 0.25%, that the slope of the cycle will be far more gradual than anyone expects, and that the end game (the ultimate interest-rate destination) will be much lower than the received wisdom currently anticipates.
And lo and behold, the Fed comes out this week to all but rubber-stamp the scenario I laid out.
Janet Yellen, the Grand Poohbah of Interest Rate Policy, told the world after the Fed’s two-day meeting that “Just because we removed the word ‘patient’ from the statement doesn’t mean we are going to be impatient.” That led the world’s economists, strategists, currency-traders and others to rethink their stance on the dollar. On the news, our greenback immediately fell against the euro because everyone finally realized the Fed isn’t in a rush to do anything.
But it’s the Fed’s changing internal expectations that tell the real story.
In particular, Fed bankers’ expectations of how high rates will go by year’s end for 2015, 2016 and 2017 fell compared to where they were in December. Fed bankers also reduced their forecast for economic growth and inflation in America, a flashing marquee that our economy is not the shining ball of strength that media hype has played up in recent months.
And all of that says our U.S. dollar is on the verge of fundamental reversal.
Holding the Status Quo
The dollar’s run of good luck has been driven exclusively by expectations that the Fed was soon to begin raising rates, probably by quarter-point increments, as it sought to normalize U.S. interest-rate policy. The implication was that normalization meant rates would move to somewhere north of 3%.
In that world, U.S rates would be moving higher as the rest of the world’s central banks are cutting rates or, at the very least, keeping them unchanged. That would mean U.S. interest rates would be widening against the rest of the world, which would naturally drive increasing numbers of investors into the dollar as they chased the higher yields.
But there’s a significant downside in that scenario. An even-stronger dollar would kneecap U.S. exporters, impaling our economy.
Equally bad, it would impale economies all over the world since so many companies and countries have taken on loads of dollar-denominated debt because of America’s uber-low interest rates. If U.S. rates rise, those dollar debts are doubly expensive to repay — the rates themselves would imply higher interest payments on adjustable-rate obligations, and the stronger dollar would mean companies and countries would have to come up with increasing sums of local currency to buy the dollars necessary to pay the debts. Some currencies would risk a crisis, and that, too, would hit the U.S. economy.
All of this is implicit in the Fed’s commentary this week. Fed governors realize they are in a no-win situation. And in that world, the best course of action is the status quo. They need the world economy to ramp up, as it’s doing now, so that other central banks can begin raising rates, too. That way when the Fed does begin to raise rates, the differential between U.S. rates and rates available in other world currencies remains unchanged, thereby keeping the dollar from strengthening.
And, thus, we come back to my original sentiment: Welcome to the beginning of the end of dollar strength.
Get Out Now
Now that the Fed has exposed its hand, investors will begin moving out of the dollar and into currencies that are fundamentally stronger than the greenback (and our greenback is structurally unsound).
I’m not saying it’s a straight shot down from here. The dollar could see a last-gasp move higher, particularly against the euro, which is close to reaching parity with the dollar. That’s the way all big trends die: the late-comers to the party don’t want to think they were stupid enough to arrive so late, so they drive the trend a little longer, and the rush of misguided euphoria makes them believe they were right. It’s a blow-off top, though, and it ends in calamity for all those who stick around – or jump in – thinking that this is the newest leg of the uptrend.
It’s the dying gasp of those too stubborn to accept that the end is nigh.
But ultimately, the dollar is doomed. The Fed has effectively promised that with its latest verbiage.
Get out while the getting is good. Go into European and Asian stocks. They will rise in value as the dollar begins its inevitable course reversal.
Next time, I’ll tell you how far the dollar has to drop once that reversal gets going.
Until next time, stay Sovereign…
Jeff D. Opdyke
Editor, Profit Seeker