Was King Dollar dethroned in November? The trade weighted US Dollar Index rose 20% from June 2021 to November 2022, its biggest bullish run since the year before the Plaza Accord in 1985. The macro ballast behind the King Dollar trend gained huge momentum after the Powell Fed abandoned its “inflation is transitory” mantra and began to raise interest rates in early 2022. The US central bank’s monetary tightening coincided with Putin’s invasion of Ukraine. The Ukraine war triggered an energy terms of trade shock in Europe that led to epic safe haven demand for the US dollar since the Euro is 57% of its trade weighted index.
At above 8% the US inflation rate was the highest since the first Regan term four decades ago and thus it was no surprise that the Powell Fed raised the US overnight borrowing rate by 400 basis points at successive FOMC conclaves. International interest rate differentials between the US and the other G7 economies, notably Japan with its yield curve control policies that pegged the 10 year JGB bond yield at 0.25%, widened as the US monetary tightening led to a sharp rise in the yields offered on US Treasury notes.
The political crisis in Britain after PM Liz Truss’s Mini Budget also led to a kamikaze dive by sterling in late September and October that boosted the King Dollar trend. Yet the US dollar was a crowded trade by early November, when the October CPI data suggested a peak in the US inflation rate, oil prices began to fall amid a peak in China’s fuel demand, Rishi Sunak replaced Liz Truss and restored confidence to sterling and US Treasury bond yields began to fall on hopes that the Powell Fed would ease its pace of monetary tightening. In foreign exchange, the trend is only your friend until the trend comes to an end and the King Dollar trend came to an end in November, a month in which the index lost a colossal 5% and now trades just below 105. This is the worst one month dollar decline since September 2010, when the Bernanke Fed revved up QE.
I cannot see the US dollar falling another 5% from current levels for two reasons. One, stagflation defines the global economy in end 2022 and a 50 basis points rate hike in the December FOMC does not mean that the Powell Fed has abandoned its mission to bring down inflation back to its 2% target. True, the pace of Fed tightening will slow but this will be mirrored by the Bank of England and the ECB, since both the UK and EU economies face a far worse energy, inflation, retail sales and industrial production outlook than the United States. Two, geopolitics will continue to boost safe haven demand for the US dollar. Russia’s missile attacks on Ukrainian cities after the Kremlin suffered epic battlefield defeats in Kharkiv and Kherson demonstrate that there is no diplomatic solution in sight to a NATO proxy war in the heart of Europe. The protest in China could also make Xi opt for “wolf warrior” nationalism on Taiwan.
Also published on Medium.
