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The dollar index has surged 20 percent since last November. And this week, it was sniffing around its 2009 high!
That’s pretty impressive, especially given that the 2009 high was driven by an across the board, global flight to the dollar … underpinned by one of the worst combinations of financial crisis and global economic recession on record.
Even more impressive: This seven-month bull trend flies in the face of the global campaigning that took place while the dollar was weakening last year. Leaders in China and Russia were among those naysayers arguing to dethrone the dollar as the world’s primary reserve currency and others pontificated its ultimate demise.
So given the dollar’s aggressive bounce back, the question is: Does it have any more gas in the tank?
The answer: YES.
In fact, the long-term cycles of the dollar index suggest this strength is sustainable and only in the early stages of a long-term bull market.
So what’s driving the dollar? And what will keep it moving to higher levels?
I’ve talked about a “win-win” environment for the buck in several of my Money and Markets columns. I even laid this evidence out in detail back in December when the dollar was bottoming. And the drivers that support the dollar haven’t changed.
The Dollar is Standing Firmly
On These Two Legs …
Leg #1:
Relative Growth
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| Bernanke’s testimony on Capitol Hill this week was encouraging for the U.S. economy and the dollar. |
Put simply, the U.S. economy is tracking a better path than its major economic counterparts. And that’s good for the dollar.
Fed Chairman Ben Bernanke said on Wednesday that he anticipates …
“Real gross domestic product (GDP) will grow in the neighborhood of 3½ percent over the course of 2010 as a whole and at a somewhat faster pace next year.”
With that forecast, the U.S. economy is expected to outperform its G-7 counterparts (the top advanced economies in the world).
If Bernanke’s projections play out, robust U.S. growth will lead to an economy operating at higher levels of resource utilization, which will lead to higher inflation expectations. Consequently, the Fed will start moving interest rates higher.
In that scenario, which many global officials optimistically share, the Fed would be positioned to be among the leaders in a new monetary tightening cycle.
But there are two BIG assumptions that fuel this outcome:
- Global economic recovery stays on path, and
- Risks, like a sovereign debt crisis, subside.
So from a growth and interest rate perspective, the dollar continues to be positioned to be a relative winner.
Meanwhile, any hiccup in those visions for a happy-go-lucky recovery path, as we’ve seen in recent months, is dollar positive. Shocks, fear, scares … all bode well for the dollar’s safe haven appeal.
And that brings me to …
Leg #2:
The Dollar’s Unique Role —
Global Safe Haven
This leg, the safe haven appeal of the dollar, is likely the stronger of the two, because the problems in Europe and the fears about sovereign debt aren’t going away anytime soon.
But even if a contagion of sovereign debt defaults doesn’t happen, still the fiscal tightening response of governments poses a big threat to the consensus forecasts for global economic performance …
Indeed, common sense suggests that tighter fiscal policy during a fragile economic recovery, which was built on policy easing, isn’t exactly a recipe for a sustained, robust outcome. With that in mind, the market expectations for global growth look overly optimistic.
And a negative surprise on global growth is a negative impact on global risk appetite — which is a positive influence on the value of the dollar.
Next, as a broader vision for the future of the dollar …
Let’s Take a Closer
Look At the Cycles
As I said, fundamentals aside, the long-term cycles offer perspective on where the dollar stands … and where it’s likely headed. I’ve shown this cycle analysis on the dollar in several columns over the past year.
So let’s revisit it …
The above chart shows the roughly seven-year cycles in the dollar, dating back to the failure of the Bretton Woods system 40 years ago. These cycles argue that a bull cycle in the dollar started in March 2008.
That would put the dollar just 2.2 years into its new bull cycle.
Back in the middle of 2009, when negative sentiment was quickly growing against the dollar, this analysis provided a solid foundation to objectively view the fundamental evidence.
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| The dollar will continue its role as a global safe haven. |
And the evidence was crystal clear: The U.S. economy had challenges ahead. But the rest of the world had, in many cases, even BIGGER challenges.
Combine that assessment with the understanding of the unique role the dollar and the U.S. capital markets play in the world, especially in periods of distress, and it all supported the cycles analysis — a bullish outlook for the dollar.
These cycles give you a big picture technical view. As for a big picture fundamental view …
History shows that financial crises tend to lead to sovereign debt crises. And sovereign debt crises tend to lead to currency crises.
Given the technical and fundamental views of the dollar, and with global fiat currencies under scrutiny, you should expect the dollar to continue to build on strength as the best alternative.
Regards,
Bryan
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