THE US DOLLAR WILL BE WEAK, BUT NOT BECAUSE OF TRUMP
At Linchpin, on the back of the work at our colleagues from CrossBorder Capital, we have been gently but consistently bearish on the US$ for a number of months now. We have been eyeing the deterioration in the quality of US capital flows, both domestic and overseas, in particular because this is always a harbinger of a weaker currency eventually, regardless of interest rate differentials and The Federal Reserve’s policy statements.
We see two major trends leading to a weaker dollar.
The first is the cash piles held by US corporates outside the US. US banks have since 2012 increasingly re- lent these back into the US and borrowed Eurodollars against them. The effect has been to boost US cashflow, effectively hiding the deterioration in cash generation from operations, and to leverage the US corporate sector. Today, these flows are drying up and we believe the effect will be to expose the shortage of operational cashflow from the corporate sector. The effect on US eps growth can be hidden for a while but not for ever.
The second major element is the flood of ‘safe haven’ money flowing out of US Treasuries, in particular into China, Europe and Japan as their economies recover. Our friends at CrossBorder Capital calculate around US$3 trillion, or 5% of total US liquidity creation in this period, went in the direction of the US in 2014 and 2015, but since early 2016 the tide has been setting in the other direction.
So we would argue that the US$ has in recent years been the beneficiary of two temporary flows of capital, both of which are slowing and reversing. Against this is the Federal Reserve’s gradual tightening of monetary policy over the past two years, which economics 1.01 tells us should act as lower US$ supply and therefore a higher 'price'. We would expect the US$ to be significantly weaker over the next 12 months. Note we haven’t even mentioned the vagaries of Trump politics!
A weaker US$ is both good and bad for investors. It will act as a further boost for Emerging Markets, a Linchpin theme for some time. However investors who use global equity managers or index funds will have over 50%, perhaps even 60%, of their assets held in US$. If we are right, that is a major risk to performance.