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Start of a multi-year downtrend for the US dollar?

Asia Analytica
Asia Analytica • 7 min read
Start of a multi-year downtrend for the US dollar?
Of late, however, there appears to be a reversal in growth expectations, driven by the country’s worsening outbreak, the likelihood of more fiscal spending and rising deficit as well as extremely dovish comments from the Fed.
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Recent US data may suggest rising odds that the economic recovery is at risk of slowing or, worse, stalling, with the resurgence in Covid-19 cases, but stocks continued to march higher. The Standard & Poor’s 500 index is back in the black year to date, rebounding 51.8% from the lows in March and is just 1.9% from its all-time record high. The positive sentiment is driving global stocks higher.

Stocks are but one class of assets that are rallying. Gold is currently trading at the priciest it has ever been, breaking above the US$2,000-an-ounce mark last week. We would not be at all surprised if prices continue to rise (see Chart 1).

Amid worries of faltering economic recoveries, geopolitical uncertainties and fears that the massive liquidity being created will eventually result in runaway inflation, gold is a safe-haven asset — especially now with historically low interest rates translating into barely any holding cost.

Gold’s zero yield is, in fact, more attractive than negative yielding bonds as a means of preserving capital. Empirical evidence shows that the price of gold is positively correlated to the amount of negative yielding debt, which incidentally is also rising rapidly (see Chart 2).

Yet another important emerging factor behind the robust gold rally is the weakening of the greenback. The price for gold, like many globally traded commodities, is denominated in US dollar. And the US dollar just recorded its worst month in years, declining sharply against a basket of major currencies in July (see Chart 3).

Even cryptocurrencies such as bitcoin are rallying (see Chart 4). We are living in a world with many “unprecedenteds” and the broad-based assets rally has shown us that some of the hottest trading themes and stocks make very little sense.

Gold, at least, is a traditional safe haven, a proven store of value for thousands of years and a core holding for many central banks. Bitcoin has no underlying fundamental value, is too volatile to be a store of value and has little use as a medium of exchange — well, except for illegal activities. It is a purely speculative asset.

We doubt the greenback’s recent decline will jeopardise its standing as the world’s reserve currency, at least for the foreseeable future. Case in point, the US Federal Reserve’s willingness and ability to quickly and significantly expand its role as lender of last resort (via swap lines with other central banks) to the world prevented a global liquidity crunch at the outset of the pandemic.

But its sharp decline in July is feeding expectations that we could be at the start of a multi-year downtrend for the greenback.

In the decade following the global financial crisis, US economic growth was one of the strongest in the developed world. Positive interest rates — compared with the negative yields in Europe and Japan — underpinned the strength of the US dollar, supporting its broad uptrend.

Of late, however, there appears to be a reversal in growth expectations, driven by the country’s worsening outbreak, the likelihood of more fiscal spending and rising deficit as well as extremely dovish comments from the Fed.

The US central bank is signalling that near-zero interest rates may persist for many years to come as it contemplates abandoning the policy of pre-emptively raising rates to head off any budding inflation. Indeed, the Fed seems ready to tolerate inflation exceeding its 2% target for a period of time, given the persistently tepid inflationary pressure of the last decade. Prior to the pandemic, the unemployment rate had fallen to record lows but did not trigger inflation, contrary to predictions of traditional economic models.

As we have previously noted, falling US interest rates have sent money flowing into emerging countries, including Malaysia’s bond market, in search of higher yields. This trend is likely to persist, with economies of emerging countries forecast to expand at a faster clip than the average global economic growth.

The euro common currency too has regained strength in anticipation of comparatively better growth outlook. Thus far, Europe, collectively, has made better progress in containing the outbreak compared with the US.

Significantly, countries appear to be closing ranks, finally — the European Union last month struck a €1.8 trillion ($2.9 trillion) fiscal spending package, built around its first-ever issuance of common debt. This could be the first step towards real fiscal, in addition to its monetary, union.

Although a weaker greenback would be negative for smaller US companies reliant on imported raw materials and consumer purchasing power, it could further fuel the US stocks rally — by enhancing export competitiveness and, significantly, earnings for big-cap stocks with large cross-border operations.

The 2Q2020 US earnings reporting season is turning out better than market expectations. According to FactSet, with 63% of companies in the S&P 500 having released their results, earnings are on track to fall 35.7% y-o-y, better than the earlier projection of -44.1%. Big caps, especially those in the tech sector, have led the market rally with market-beating earnings results. The Nasdaq is up 22.6% year to date.

Qualcomm, the world’s biggest supplier of modem chipsets, was the top gainer in the Global Portfolio last week. Its shares surged 21.8% to an all-time record high after the company struck a long-term patent agreement with Huawei, which includes US$1.8 billion ($2.5 billion) in a one-off back settlement.

Last year, Qualcomm settled a similar long-running patent lawsuit with Apple, one of its biggest customers. This means the company will now be collecting licensing fees for its suite of patents from all the major phone manufacturers.

Smartphone sales are expected to recover from pandemic-hit depressed numbers, lifted by the anticipated big 5G replacement cycle, which also boasts up to 1½ times dollar chip content of typical 4G phones.

The two other notable gainers for the week were Builders FirstSource (up 17.6%) and BMC Stock Holdings (up 18%). Both building materials distributors are rising on a bullish outlook for the US housing market.

That said, the sharp rebound in lumber prices — aided by the US dollar weakness and robust demand amid tight supply — could hurt margins in the short term, depending on how quickly selling prices for value-added products can be adjusted to reflect the higher input costs (see Chart 5).

The Global Portfolio ended 4.6% higher for the week ended Aug 6, boosting total portfolio returns to 29.2% since inception, an all-time record high. This portfolio is outperforming the benchmark MSCI World Net Return index, which is up 17.7% over the same period.

Only Alphabet and Vertex Pharmaceuticals finished the week in the red, losing 1.6% and 1.9% respectively. Although Alphabet’s latest quarterly earnings came in ahead of market expectations, it reported the first-ever revenue decline (-2% y-o-y) on the back of sharp cutbacks in global ad spend.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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