13.09.2022 –Topsy-turvy world: The dollar is stronger than it has been for a long time. Because of the Federal Reserve’s interest rate turnaround. And now, of all times, some forecasters are calling for a short trade. Because of the Federal Reserve’s interest rate turnaround. We shed light on the background to the surprising turnaround.
Corona crisis, Ukraine war, higher interest rates in the U.S. than in Euroland: the greenback has served as a safe haven for many investors for quite some time. Investors are fleeing the emerging markets in particular. And since the energy crisis in Europe is likely to hurt domestic industry, we have another argument pro dollar and contra euro. Here EURUSD in a weekly chart.
But wait – suddenly there is a new assessment of the situation by some analysts. Surprise: Dollar short could become enormously lucrative. Because the political costs of raising interest rates are too high. So those who are betting on a further slide of various currencies against the dollar could be wrong.
Beware of bear traps
On that note, Lawrence ‘Larry’ G. McDonald has just spoken out, he is a best-selling author and founder of ‘The Bear Traps Report’. This is an investment newsletter focusing on the macro perspective. McDonald points out a rarely highlighted fact: Currently, he says, the Fed is secretly, quietly, paying about $250 million to a few banks – on a daily basis.
The reason: For 14 years, financial institutions have been forced to avoid risky investments in the course of risk reduction; this is called deleveraging. Instead, they have increasingly invested in U.S. bonds. And here we have landed on the subject of the dollar short: As interest rates rise, the Fed would have to pay these banks more and more money for coupons. And the Fed would soon incur losses. No wonder with an increase from 25 to 325 basis points in a few months – and who knows where the Fed Fund rate will stop. McDonald called the social cost of tightening rates and redistributing wealth too high.
Trade of 2023
In the same vein is a statement by Michael Hartnett, who has been quoted here several times, that is one of the best analysts on Wall Street. The chief investment strategist at Bank of America recently called out the top trade of 2023: Dollars short and long in emerging market assets, global addresses in the UK, internet stocks in China and in gold miners. But that’s only after the US recession begins – these will signal the peak in the dollar; and also only after the economic trough in China, which will likely be accompanied by a devaluation of the yuan. Specifically, Hartnett’s Top Trade 2023 looks like this: “Our high conviction – U.S. dollar bear basket is locked and loaded – EWZ Brazil, EEM Emerging Markets, FXI – KWEB China, global value names in EMU and gold miners GDX.” Where the abbreviations stand for index funds.
Risk of Overtightening
Indeed, Fed Vice Chair Lael Brainard has just fueled such thinking: “There’s a risk of raising rates too much.” She referred to the “global nature…. risks with overtightening.” We wonder if the experts are right, and if the Fed actually has in mind moving away from tightening so as not to send the economy into recession by twisting off cheap money. If the banks cash out while millions of people go into unemployment, that would be explosive indeed. Things remain exciting – Bernstein Bank is keeping an eye on the situation for you!
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