Reporter of the Economic Business: Cai Ding Reporter of the Economic Business Business: Gao Han
Fed Chairman Powell once vividly compared the formulation of monetary policy to walking in a dark room: You have to walk slowly to avoid painful results.
However, now the global central banks led by the Federal Reserve no longer have the patience to "go slowly" - after inflation hits like a "flood", they decided to make big strides, while major central banks have different steps in monetary tightening.
" Daily Economic News " reporter noticed that since the Federal Reserve's September interest rate meeting (FOMC) was held on September 20, the rise of the US dollar index has accelerated significantly, setting a 20-year high almost every day. As of the close of Tuesday, September 27, the US dollar index has risen by 19.48% this year. The US dollar appreciated 21.46% against the euro, 20.67% against the pound, and 25.21% against the Japanese yen.
It is not only the foreign exchange market that is "injured", but the "hawkish" Federal Reserve also caused the S&P 500 index and the Dow Jones Industrial Average to fall into bear markets one after another, and house prices in 20 cities in the United States recorded their first decline since 2012.
The dollar index continues to rise under the Fed's aggressive tightening cycle, which has triggered market concerns about the recession. Xinhua News Agency quoted an article from " New York Times " saying that Federal Reserve's interest rate hike caused inflation in many countries to rise rapidly, and the scale of debt continued to expand, increasing the risk of a severe global economic recession.
So, how can the strong dollar that has not been seen in 20 years be reappeared? Should the Fed worry about the risk of excessive tightening? How will the US and the global economy perform under the strong dollar? How should investors allocate assets during the cycle? With these questions in mind, reporters from the "Daily Economic News" (hereinafter referred to as NBD) talked with chief economists and strategists from many top international institutions to explore the dangers and opportunities under the "strong dollar storm".
The combined effect of multiple factors has led to the strengthening of the US dollar, and the momentum may continue until the beginning of next year
NBD: What are the reasons behind the continuous strengthening of the US dollar this year? Will the US dollar continue to strengthen?
Dutch International Group Forex strategist Francesco Pesole: The strengthening of the US dollar is the result of the combined effect of the Federal Reserve's tough stance, energy crisis and poor performance stock markets.
Initially, (just hawkish) the Fed was helping the dollar strengthen, as the Fed rate hikes widened its spread with other major central banks (such as the European Central Bank), which was conducive to the dollar strengthening. At this stage, the Federal Reserve is still supporting a strong dollar, but its hawkish tone is mainly to influence foreign exchange through risk sentiment channels. , the Federal Reserve's hawkish stance puts pressure on stocks and other risky assets, thereby stimulating safe-haven funds to flow into the US dollar.
Secondly, the energy crisis and geopolitical fluctuations in Europe are another major driver of the dollar's strength, as this negatively affects some major non-U.S. currencies such as the euro and the pound.
We believe that USD will still have room for continued strengthening until the beginning of 2023. On the one hand, it is because the Fed will continue to raise interest rates in in the new year, and on the other hand, it is because the (European) natural gas supply situation deteriorates, and this winter may pose a considerable challenge to the eurozone.
This week the US dollar index continues to hit a 20-year high (Picture source: Yingwei Financial Information)
NBD: Some people point out that the current "cheap dollar" is becoming less and less (i.e., "dollar shortage"). So, what is the difference between the current " dollar shortage " and the "dollar shortage" that appeared in March 2020?
Fitch Ratings Chief Economist Brian Coulton: The recent strengthening of the US dollar not only reflects the impact of energy asymmetric shocks on Europe far exceeds that on the United States, but also reflects the Federal Reserve's hawkish stance relative to other major central banks. In this sense, the current "dollar shortage" is different from the "dollar shortage" in March 2020. At that time, due to the market's concerns about the impact of the new crown pneumonia pandemic, companies in the United States and around the world rushed to buy US dollar cash.
Jeffrey Global Equity Strategist Sean Darby: The "dollar shortage" two and a half years ago was because of the worst period of the new crown pneumonia epidemic. Before the Federal Reserve began to intervene in credit and bond markets, market concerns about deflation and the rise in the safe-haven position of the US dollar. In contrast, the current round of "dollar shortage" in is due to the overheating of the US economy, which has led to the Federal Reserve's acceleration of tightening.
The United States exports domestic inflation under the strong dollar, intensifying the monetary policy of other countries challenges
NBD: In the context of the continuous tightening of the global monetary environment and the impact of the strong dollar, how do you view the prospects of the global economy?
Mitsubishi UFAN Financial Group Global Market Research Head Derek Halpenny:The situation in the global financial market continues to deteriorate, which is obvious in the foreign exchange market. The strength of the US dollar against many national currencies is reaching extreme levels.
There are many reasons for the deterioration of financial conditions. Another sharp rise in long-term Treasury yields is an example, not only in the recent UK. The yield on the 10-year U.S. bond exceeded 4% this week, hitting a new high since 2010.
10-year U.S. Treasury yield hit a new high since 2008 this week. Image source: Yingwei Finance
Secondly, after a large-scale leak in the Nord Stream pipeline from Baltic Sea to Germany, uncertainty in natural gas supply (European) rose again. While these pipelines currently do not deliver natural gas, the leakage itself highlights future risks.
If the current rise rate of the US dollar continues, its transmission effect on the stable damage of the global market will only further intensify, increasing the risk of global recession.
Someone also asked us what the prospects of collaborative intervention of G7 and even G20 will be. We think it is unlikely at this critical moment, but in such a market and unprecedented times, we should not rule out any possibility. Politically, it is difficult for the United States to participate in actions that are believed to push up inflationary pressures in the United States, but if the situation continues to worsen, coordinated global intervention will become more reasonable once the U.S. midterm elections end on November 8.
Fitch Rating Brian Coulton: A strong dollar means that the United States is exporting domestic inflation, increasing monetary policy challenges in other countries.
In addition, since June this year, has also lowered its growth expectations for global GDP due to factors such as the natural gas crisis in Europe and the acceleration of global monetary policy tightening. We currently expect global economic growth to slow to 2.4% and 1.7% in 2022 and 2023, down 0.5% and 1.0% from our June forecast, respectively. The economic scale involved in this downward adjustment is very large and the geographical scope is quite wide.
NBD: From the current stage, is the Fed still possible to achieve a "soft landing" or will it cause a moderate recession?
Fitch Rating Brian Coulton: Soft landing (i.e. GDP continues to grow slowly but unemployment is not rising) seems unlikely to achieve. Historical evidence of the currency tightening leading to the US economic recession cannot be ignored. Our basic forecast for 2023 is an economic recession.
This seems to be one of the fastest currency tightening cycles in U.S. history, with interest rate hikes from bottom to top only 10 months past. Nevertheless, we expect the US recession to be quite moderate. Currently, the financial situation of US households is much better than in 2008, the banking system is healthier, and there is little evidence that the real estate market is overheating.
We expect the upcoming recession to be roughly similar to the recession from 1990 to 1991, when the Fed was in the late stages of rapid tightening of monetary policy. However, the current downside risk comes from the ratio of non-financial debt to GDP, which is currently much higher than in the 1990s. Finally, the impact of QT (quantitative tightening) on asset prices is also highly uncertain.
U.S. real GDP has declined month-on-month for two consecutive quarters. Image source: U.S. Bureau of Economic Analysis
Ernst & Young Chief Economist Gregory Daco: In early May this year, Powell pointed out that (former chairman of the Federal Reserve) Volker "has the courage to do what he thinks is right", even if it requires rapid tightening of monetary policy and triggering an economic recession. Since then, Powell’s concept of achieving a “soft landing” has become increasingly transparent—and if possible, it will be very difficult.
The Federal Reserve will need to slow down the pace of U.S. economic growth and rebalance the supply and demand relationship. Powell has repeatedly stressed that the Fed's mission is to reduce inflation by achieving "under-trend growth and softer labor market conditions" over a period of time. Although Powell did not publicly say that the Fed's economic forecast means an economic recession, it is indeed the case. How to allocate global assets under the strong US dollar?
NBD: How should investors allocate their assets under the current strong dollar cycle? Is it still a good investment to go long at this stage?
JeffreySean Darby: As the dollar financial environment is "overly" tightening, the currency is becoming disorderly - the same as the price trend in March 2020. Investors need to pay attention to the reactivated of the US dollar swap quota and go long volatility. When the real interest rate is positive, deflation of real estate (asset) prices will begin to complicate the interest rate hike cycle, which is what we call "stagflation" will occur.
is measured by almost all valuation indicators including PP (private power parity), REER ( actual effective exchange rate ), and the current US dollar is expensive. USD is overvalued at least 20% relative to other developed currencies. We believe this will be one of the major M&A drivers, as U.S. companies with a large number of “expensive” dollars want to take advantage of the exchange rate mismatch to acquire overseas businesses.
As the Fed raises its rate hike expectations, the sovereign credit spread will increasingly distinguish between strong and weak balance of payments levels. For the more recession part of the stock market, it is too early to " buy at the bottom". Investors should avoid investing in real estate. Adjustments in commodity markets, rising freight rates and recovery of supply chains will provide most bond markets with a "disinflation" background, and deflation in real estate prices will become a more serious problem in 2023.
We are also making some adjustments to asset allocation. We recommend further reducing cyclical risk exposure , adjusting the rating of the materials sector to bearishness, and adjusting the rating of the energy sector to moderate bearishness. In terms of precious metals, it is no surprise that gold denominated in US dollar has been under pressure given the strengthening of the US dollar and the almost "schizophrenia" shift in the Fed since Powell's attitude in November last year (and this shift can be largely explained by political pressure).
Price trend of gold denominated in USD in the past year Image source: Yingwei Financial Information
There is no doubt that If the Fed's position suddenly changes, gold and silver with high " beta value " will become the main beneficiaries, whether it is due to the Fed's sudden concerns about the recession or its related decision to bypass the 2% inflation target. From the relative performance charts of coal and silver stocks since silver prices peaked in August 2020, it can be seen that the market has huge potential to shift from energy to precious metals.
Is the Federal Reserve over-tightening?
NBD: How will the inflation and unemployment rate in the United States change next, and to what extent will these changes affect the Fed's interest rate cut path?
Fitch Rating Brian Coulton: We do expect U.S. energy and food price inflation to fall next year, and core commodity price inflation (except energy) has peaked. However, what is really worrying is the inflation in the service industry, which will continue to rise and is now above 6%.A key indicator here is wage growth— If the labor market remains very tight and wage growth has risen sharply, the Fed's attitude will become tougher.
NBD: The FOMC policy statement in September released a clear hawkish signal, and the rise of the US dollar index accelerated significantly after that. In your opinion, should hawkish FOMC be concerned about the risk of over-sustainment?
Fitch Rating Brian Coulton: We are in amid a huge change in the global real interest rate environment, which is having an impact on all financial assets. However, FOMCs don’t need to worry about the risk of over-tightening, and the Fed’s top priority is to ensure inflation returns to its 2% target in the medium term, and their only tool to achieve this is to tighten monetary policy. , despite the rapid rise in interest rates in recent days, is still only slightly above the neutral level.
EY Gregory Daco: Against the current global synchronous but inconsistent central bank tightening cycle, Powell hinted that the Fed is indeed paying close attention to developments abroad, because the monetary policies of other countries have a great impact on domestic economic activities in the United States. Nevertheless, we believe that the lack of proper policy coordination, as well as the lack of rate hikes and synchronization, may lead to excessive tightening of (Federal) monetary policy, resulting in excessive and disorderly tightening of financial conditions.
This historic tightening cycle is an important factor that policy makers need to weigh, which could lead to a more severe global economic slowdown than expected by the Federal Reserve and global financial markets.
Barclays senior US economist Jonathan Millar: (Fed) This selective focus on labor market data and inflation indicators will provide adequate reasons for a sharp rate hike, many of which may lag behind cycles or show significant delays when the Fed rate is being negotiated. However, this also significantly exacerbates the risk of the Fed's over-tightening. The Federal Reserve's reduction in importance on the risk of excessive tightening greatly increases the possibility of a recession next year.
Disclaimer: The content and data of this article are for reference only and do not constitute investment advice. Verify before use. Operations based on this are at your own risk.
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