Friday, April 21, 2017

FX: "State of Dollar Bull Market"

This is yesterday's Marc to Market, we'll have the link to today's after the jump.
Dollar Index (DXY) 99.82 up 0.13.
From Marc to Market, Apr. 20:
The Federal Reserve's real broad trade-weighted dollar fell for the first three months of 2017, and the greenback's heavy tone this month has raised questions about the state of the bull market. Despite this recent weakness, we think the bull market is intact and that the advance will resume.

In the February through April last year, the real broad trade-weighted measure of the dollar fell. Many investors doubted the bull market was intact. The greenback proceeded to rally seven of the following eight months. In 2015, this measure of the dollar fell in three of the 12 months, and two were back-to-back (April and May). In 2014, there was a three-month losing streak (March-May). It then appreciated in six of the following seven months. Of course, history does not repeat itself.

The Great Graphic here depicts the real broad trade-weighted index(white line) and the euro (yellow line). The chart goes back to 1990. I am uncomfortable showing two time series on two scales on a single chart, as this practice seems abused on Wall Street. However, for given this, the two track each other pretty closely and for good fundamental reasons. Europe is a significant US trade partner and shares many of the same drivers of headline inflation, like energy.

To assess the dollar's bull market in a disciplined fashion, and to avoid getting caught up in short-run disruptions, we come back to our assessment of the driver. We argue that first significant dollar rally post-Bretton Woods (the Reagan dollar rally) was driven by the policy mix of loose fiscal policy and tight monetary policy (under Volcker). The second dollar rally (Clinton dollar rally) was driven by the carving out of the internet (leading to the tech bubble)/ We note that the Fed began raising rates in 1994 and the dollar's bull market began in the spring of 1995.

We see the current dollar rally (Obama-Trump), the third since Bretton Woods. What allowed us to anticipate it was our understanding of the driver: Divergence of monetary policy broadly understood. The Federal Reserve responded early and aggressively to the financial crisis. It began its unorthodox policies in 2009, several years before the Bank of Japan and the ECB began their efforts. This, coupled with the flexibility of the US economy, produced results earlier, allowing the Fed to exit and begin normalizing policy before most of the rest of the world.

The question of the state of the dollar bull market is a question, in our mind, of whether divergence remains intact. We think it does. Softer Q1 GDP, with the pullback in consumption, we judge as a temporary soft patch. Growth in the January-March period has been typically soft beginning in 2010. From 2010 through 2016, growth in Q1 has averaged 1.1%. Growth in all the other quarters has averaged 2.5%....MORE 
And April 21: