Article / 11 October 2016 at 11:02 GMT

Macro Digest: Why USD is about to move much higher — #SaxoStrats

Chief Economist & CIO / Saxo Bank
  • Greenback strength to hit deficit currencies hard
  • Treasury yield charts significant for USD rally
  • Deficit currency performance tied to Fed projections

By Steen Jakobsen

Both Saxo Bank head of forex strategy John J Hardy and I are of the view that the currencies of countries showing current account deficits are likely to fall in value against the greenback.

In Hardy' view, published on earlier today, "a further rise in US yields could intensify the pressure on currencies of the world’s current account deficit nations, from Australia and New Zealand, to emerging markets."

To this I would add the following...

First, take a look at the US two-year Treasury yield chart – this is important as it's a key short-term benchmark for Federal Reserve policy.

As you can see, we have already risen over 25 basis points from the low in this cycle.

Two-year Treasury yield

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Source: Bloomberg

Second, consider the almighty benchmark at 1.7500 in the 10-year Treasury.

10-year Treasury yield
Source: Bloomberg

This brings us full circle… deficit countries/currencies are highly USD-financed and as the cost of capital rises, the currencies will weaken.

The ZAR, AUD, TRY, and CAD have outperformed relative to both these countries' economic but also political climates. This has near-exclusively been driven by a weaker US dollar and a less aggressive Fed. 

Now, this trend seems to be reversing..

We are core long $-TRY, $-ZAR, and short CAD and AUD. This is performance including carry… 

(The chart below shows long USD, hence the outperformance by deficit currencies is shown as a falling line.)

Note how the deficit currencies were “low” when the Fed promised four of five interest rate hikes one year ago.

Source: Bloomberg 

As you can see, since the Fed stopped talking about four/five hikes in early 2016, the deficit currencies outperformed – dramatically so. Then we saw a low in August and we are now getting into a net gain as a portfolio, even including negative carry (when long USD).

(Also: don’t forget US money market reform starts this weekend… )

You can ignore the fact that the cost-of-capital is rising in the US, but you can’t run from it in the medium and long terms.

We see the above as two interlinked macro moves that should lead to further USD strength from here.

Flying high... Photo: iStock 

— Edited by Michael McKenna

Steen Jakobsen is chief economist and CIO at Saxo Bank

Santa Rita Mark Santa Rita Mark
For the novice, like me, could you please explain the implications for the investor thinking about purchasing more US treasuries? Would you advise purchasing or waiting? Would you advise TIPS? Thank you.


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