Monday, September 25, 2023
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Jackson Hole hawks Fed ready to end dollar rally

(Bloomberg) — The dollar’s recent rally should soon lead to a decline in global trade — and demand for dollar-denominated assets — leading to a weaker greenback. Paradoxically, the catalyst for this decline could be a more hawkish Fed at this week’s Jackson Hole meeting.

Yields and yield curves indicate flow-driven demand for U.S. dollars and U.S. dollar assets, and U.S. dollar levels have an impact on the stock of those assets. A rising dollar makes it more expensive for foreign borrowers to service their debts, creating deleveraging pressure. It also makes the cost of purchasing new dollar assets more expensive in foreign exchange terms.

But the main driver of global capital flows is trade. Capital flows are the flip side of trade flows, and trade imbalances create capital imbalances that drive capital flows.

Almost all major commodities are traded in US dollars (with some notable exceptions such as wool, Australian dollars). Therefore, as foreign currency prices for all goods rise, a rising dollar will eventually dampen global trade. Global trade is faltering as the dollar appreciates, meaning capital flows are falling.

Deleveraging pressure from a stronger U.S. dollar and a slowdown in largely U.S. dollar-denominated global trade led to overseas trading of U.S. assets.

Foreign holdings of U.S. long-term financial assets have fallen from 27.$3 trillion to 23.5 trillion US dollars, the US dollar index rose nearly 23% over the same period. Foreign transactions of U.S. assets fell 10% year over year.

Jackson Hole could be a buy – Rumors are a factual catalyst for a lower dollar, especially if Fed Chair Jerome Powell takes a hawkish stance. fight inflation. In anticipation, yields have been rising and the dollar has been rejuvenated, gaining against all G-10 currencies over the past few weeks.

Yield differentials in almost all G-10 currencies are positive for the US dollar (New Zealand being the only notable exception). But the difference between nominal and real yields does not have a solid leading relationship with the dollar.

One of the best leading relationships for the dollar is the real yield curve. After surging for most of last year, it is now clearly rolling, suggesting the dollar will soon run into resistance.

Real returns for foreign investors in U.S. Treasuries are falling as front-end real yields rise more than long-term yields. Therefore, a flattening of the real yield curve indicates impending resistance for the dollar.

The Japanese are the biggest buyers of U.S. Treasuries, but have been noticeably absent from the market this year as a sharp rise in U.S. short-term interest rates has led to higher foreign exchange hedging costs.

If Powell leans hard on Jackson Hole, the real yield curve will face further flattening pressure, especially if the market continues to believe the rate-cutting cycle could begin as early as next year. So, paradoxically, after any knee-jerk reaction, the more hawkish Fed put more resistance on the dollar in the medium term.

But even if Jackson Hole is unscathed, the dollar is strong

  • Note: Simon White is a macro on Bloomberg’s Markets Live blog Strategist. The observations he makes are his own and not intended as investment advice. For more market commentary, see the MLIV Blog

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