Good morning, if there is a crowded trade out there, it has to be the one which is short the US dollar. Before going any further, let’s remind ourselves that there are two parts to every currency pair and that the exchange rate reflects the relative value of the two currencies to each other. The exchange rate, therefore, tells two stories at the same time. Thus, as the Aussie Dollar trades above USD0.8000, one needs to look at the performance on both sides of the party, assess the way the market is positioned and then decide if US$0.8000 is a buy or a sell.
I happened upon an interview with David Bloom, HSBCs outspoken head of global forex strategy in which he too appears to believe that the current dollar sell-off looks to be overdone and that the shorts are at risk of being swept up by a snap back in the greenback. Rather tellingly, he also added that forex markets are poor predictors of central bank policy and that if one wants a view in that direction, its best to follow bond markets which he held up as being much smarter at reading central banks than even they are themselves.
According to Bloom even the Fed has got the Fed wrong. He seemed to be saying that all monetary authorities’ valiant attempts at forward guidance has achieved has been little other than to have confused themselves whilst bond markets have seen through them and generally ended up with a better track record of getting them right than they have done. Maybe it’s because the markets are playing for money and not for matchsticks where mistakes cannot be verbally reversed but unequivocally show up in the P&L.
Thus, despite all the hawkish talk from the likes of the Fed, the BoE and the ECB, bond prices reflect much less fear of tightening than the varied rhetoric emanating from the top would have one believe. Although it is my personal belief that the escape route out of the low to no inflation environment ought to be plotted down the route of higher interest rates, I have also argued that it is unlikely that monetary policy will go that way.
Contemporary thinking – and not only in the monetary policy space – is that whatever has to be done must, at all cost, be done without anybody getting hurt. We find ourselves, going on 10 years after the beginning of the GFC, with a financial system weighed down by eye-watering debt levels which were run up in order to avoid the developing melt-down in the aftermath of the sub-prime crisis. The financial system survived on the back of interest rates plummeting at the same rate at which debt was rising, thus effectively maintaining public sector debt servicing costs level.
The elephant in the room, the question nobody ever dares to ask, is what happens to public sector finances if the cost of interest payments – forget debt repayment – were to begin to meaningfully rise. Markets are not very good at doing “a number of years” but as good as they ever are, the bond market comes closer to being able to think beyond the end of its own nose it than does the forex market.
Bond markets are telling us that rates are going nowhere in a hurry and they may well be right. What David Bloom thinks a weak dollar might be trying to express in monetary policy terms escapes me slightly. The central banks and their monetary policy are gridlocked and whatever they do they will have to do at the pace of an ageing snail with rheumatism.