Is there a massive US Dollar long accumulating and will it unwind?
The Idea
It was 8/27/2024 when Kit Juckes gave an interview at Bloomberg surveillance and brought light to the massive USD long and how he has seen that same position unwind twice before.
The idea is simple:
There was a massive US Dollar Index long back in 1985, one in 2001 and one now. This is a once in a generation opportunity.
So yes given the strength of the dollar and recent All TIme Highs in the US indices there is a massive long but when will it unwind?
Why would it unwind?
The trigger would be the shift to a rate cutting cycle which would be global and a shift from restrictive monetary policy to a neutral one.
The US monetary policy was accommodative for the longest time and once inflation hit hard it shifted to restrictive with rates rising all the way to 5.5%. Given US exceptionalism this was the place to collect Effective Margin and the best carry.
This is about to change.
The JPY Case study and similarities
An example is the USD/JPY because the policy of the FED vs the BOJ are opposite. The Fed is cutting while the BOJ is hiking thus squeezing the margin on the Dollar long that had accumulated. With the Conclusion being JPY strength.
Given the rate cutting cycle will be coordinated with the G-10 members and globally, JPY strength is expected against all of the G10 Currencies. This is the result of the squeeze on the margin and to the carry.
As rates drop and depending on the state of the US economy the US dollar might not be the best place to collect the carry and the effective margin.
So No1 Reason is that there are higher margins to be made elsewhere, cheaper and easier money.
The dollar as the Reserve Currency Argument
A viewpoint that many analysts have is that the dollar will not weaken unless there is a shift in the status of the dollar as the reserve currency of the world. By no means is the dollar going to lose its global status but a diversification in currencies held as reserves will happen and is happening.
As described in the article “Dollar Dominance in the International Reserve System” on the IMF blog by Serkan Arslanalp, Barry Eichengreen and Chima Simpson Bell there is an erosion of the dollar as the dominant reserve currency. A lot of that erosion has been masked because of dollar strength and this time around non-traditional currencies are becoming part of the mix such as the USD/CAD, AUD/USD, USD/CNY.
The US Exceptionalism Argument
The next argument as to why the dollar will not weaken is that there is nowhere else to invest as good, safe and with the potential of the US. That statement holds true. The US consumer has been the strongest and Big Tech has a disproportionate valuation.
As for big tech there is little competition and diversification that can happen.
The two questions are the state of the US consumer and what the broadening of the rally really means. It is important to remember the massive stimulus that took place in the US during COVID and how that led to inflation. The US job market is cooling and we are seeing signs that the US consumer is becoming more choiceful as they say in Bloomberg Surveillance. With the USD strong, the landing taking place soft or hard and the initiation of a rate cutting cycle is this where the best carry can take place and where the best effective margin is?
Especially as the rally broadens; why some of the broadening might not spill over to other areas, countries or economic blocks that have better growth potentials.? Not talking about big tech but about the other 493 companies in the SP500 or the 2000 ones in the Russell, bonds, real estate etc.
The EURO case study and global correlations
The single currency holds the second largest share in reserve currency and saw a massive rally in the early 2000’s. That period was characterized with German exceptionalism, EU enlargement and the addition of all the former Soviet bloc countries, the US war on Terror and the rally of commodities. Similarly if the US Dollar is to enter a period of weakness where would the flows head towards? What other trading blocs or areas that have positive characteristics would attract inflows and direct investment?
Final thoughts
The USD will not collapse and the era of US supremacy is not coming to an end. Geopolitics are coming to the forefront again with global instability. Russia, China, South East Asia, Africa and all over the globe.
America was never meant to be a global empire but the First Amongst Equals. Where will the capital flow to now to build up the next trading Bloc and create more equals?