by Chris Black
This is the “milkshake theory” (www.youtube.com/watch?v=PWVRWUkm54M) in the context of a strong dollar; that is, as capital flees other countries for dollar-denominated assets, either to seek higher yields on Treasuries or to service existing dollar debt, dollar demand builds FX pressures beneath the dollar and the end result is a surge in relative dollar strength (and relative pain in whatever emerging currency (www.bloomberg.com/news/articles/2022-07-28/how-a-strong-usd-dxy-is-pushing-the-global-economy-to-recession)).
This effect is particularly visible in the EU and Britain, the latter of which restarted QE (www.bankofengland.co.uk/news/2022/september/bank-of-england-announces-gilt-market-operation) a year ago as the pound almost hit parity with the dollar (www.bloomberg.com/news/articles/2022-09-01/once-unthinkable-parity-for-sterling-is-fast-on-the-horizon).
It became clear last year that Europe was taking marching orders not from Belgium but from Washington, as evidenced by the Ukraine war (www.politico.eu/article/europe-ukraine-russia-war-us-joe-biden-fear-what-happens-if-the-us-pulls-back/), central bank operations, and a flurry of insane domestic policies (www.msn.com/en-ae/news/world/rishi-sunaks-net-zero-gamble-puts-britains-economic-future-at-stake/ar-AA1gZziv).
Dollar strength is primarily measured against the euro (70% when including the pound), so to strengthen the dollar requires capital flight out of Europe, hence why Germany is shooting itself in the foot by de-industrializing .
Last year’s BoE operations had the effect of rebalancing Britain’s FX rate and taming a runaway dollar, but what if dollar strength returns?
Dollar price action is indicating that a resurgence in FX pressures is already here — the last nine consecutive weeks (www.thedailystar.net/business/global-economy/news/dollar-gains-8th-straight-week-3415726) have seen a rally in the USD’s FX rate (this week could be the 10th).
It’s very likely that, sooner than later, we see a dollar back to last year’s highs at strength that broke the BoE, and sent the BoJ into a panicked attempt to protect their yen.
In fact, the dollar/yen FX rate is already at levels where BoJ intervened last year. The dollar milkshake is even putting downward FX pressure on China (www.bloomberg.com/news/articles/2023-09-19/china-s-worst-capital-outflow-in-years-spells-more-yuan-pressure).
We will likely see a return in BoJ interventions and de-dollarization hype in the coming months, the latter due to increasingly unfavorable import costs on dollar products in emerging markets and an unpopular American regime.
Fast forward to today — FOMC day, when a Fed committee announces amendments (if any) to the public regarding interest rate or policy changes.
Last Thursday, the ECB met and surprised the world not only with an unexpected rate hike (t.me/marketfeed/440777), but also the suggestion that they were done with rate hikes (t.me/marketfeed/440840), even as real rates (interest rate minus inflation rate) remain negative!
The market responded by dumping euros and fleeing into dollars (www.marketpulse.com/forex/eur/video-eur-usd-tumbles-after-a-surprise-dovish-ecb-rate-hike/cerlam).
A worst case scenario for Europe is for rebound inflation to force the ECB back to hiking – destroying their credibility and guaranteeing stagflation.
For the Fed to hike at today’s meeting would accelerate Europe’s demise.
FWIW, I do not think that they will hike today (they will hike in November amid resurgent inflation (www.businessinsider.com/us-economic-outlook-inflation-rebound-debt-government-spending-gas-prices-2023-8)), but time will tell…