The US Dollar Index’s 4.5 per cent rise since mid-April has myriad causes.
1. The Italian election annihilated the political center and produced the worst possible coalition scenario of the far left (Five Star) and the far right (Northern League), two populist, anti-euro parties that won 54 per cent of the vote. Italy has a de facto bankrupt banking system, a 130 per cent public debt/GDP ratio, vast regional inequalities (Milan and Calabria are different planets, as are Lombardia and Veneto from Sardinia) a toxic Mafia presence and a fiscal nightmare. Now its politicians want to renege on the fiscal/pension reforms imposed by Berlin and Brussels in 2011. This is the nightmare scenario for the euro and the euro is 57 per cent of the US Dollar Index.
2. The Italian-German Bund debt spread has surged, as has Italy’s risk of sovereign default. The euro’s fall to its SNB’s floor against the Swiss franc at 1.20 is an ominous message of systemic risk. There is no way the ECB can begin quantitative tightening in September. A premature end to Dr Draghi’s asset purchase programme could literally trigger a Greek-style sovereign debt crisis – only on a far bigger scale. Italy has the third-largest bond market in the world. If Italy goes bad, Planet Forex will script the requiem for the euro and the dream born in the Treaty of Rome. The safe-haven bid in the US dollar has only just begun.
3. The US-China deal averts an immediate trade war, though it is mathematically impossible for the US trade deficit to fall $200 billion on higher Chinese imports of US energy and agribusiness products. Chinese exports to the US will have to fall, a real risk to growth in Japan, South Korea, Taiwan, Singapore and Malaysia. Net-net, this means lower Asian currencies against the US dollar.
4. The correlation coefficient between the greenback and Uncle Sam debt yield has risen in the past month with a vengeance. Japanese inflation data shows Governor Kuroda’s 2 per cent inflation target is a central banker’s midsummer nights fantasy. This means there is no chance that the Bank of Japan will exit its zero bond yield policy in 2018. Shinzo Abe is mired in a political scandal and yet another LDP factional night of the long knives. The path to ¥110, a target I outlined a month ago, was inevitable given US Treasury-JGB yield spreads, Fed-BoJ monetary tightening timetables and the political time bomb that now haunts Abenomics.
5. The risk of emerging markets contagion is all too real as I watch the Turkish lira and the Argentine peso meltdown. There is $220 billion in external debt issued by non-financial Turkish corporates. There is $14 trillion of debt outside the US held by non-American banks. Deutsche Bank has $25 billion in equity capital and $1.7 trillion in liabilities. Is there a Lehman scale banking time bomb in Europe? Is the Pope Catholic? The world is on the precipice of a major funding and debt crisis. The US dollar is the world’s natural safe-haven currency as the US banking system is the only true credible deposit insurance scheme for savings when the lights go out in Europe.
6. I was stunned to see the Canadian dollar trade as low as 1.2980 (Nafta?) even though Brent crude surged to $80 a barrel. When petrocurrencies fall while Brent hits 4-year highs, I get nervous. I remember the bitter memories of 2007 when I seriously thought that we were doomed to relive the Great Depression. Every post-war US recession has been preceded by a surge price of crude oil. Will the recession of 2019 be any different?
7. Financial markets now ignore the US trade and budget deficits and focus on relative US economic outperformance versus Europe. This is the reason the Fed Funds futures contract implies three more rate hikes in 2018 and two rate hikes in 2019. King Dollar is back from its post-election Trumpian netherworld and King Dollar will now kick (rhymes with) glass My next target? ?1.08.
8. AKP’s top economics honcho Mehmet Simsek will fly to London to reassure terrified investors. Too little, too late; a financial crisis and deep recession is now inevitable even as Erdogan goes to the polls to seek reelection on June 24. The Ottoman Empire died amid a tsunami of foreign debt. A deadly endgame awaits the world on the Bosphorus.
