Why 13D Founder Kiril Sokoloff Is Bearish On “The Most Crowded Trade In The World”
Two weeks ago, when laying out the ongoing battle over the most controversial proposal in Trump’s economic plan – the Border Adjustment Tax – we said that one of the biggest, and still undetermined unknowns is whether Trump will pursue a “stronger or a weaker Dollar” as there is a distinct lack of coherence between some of his fiscal proposals and their contradictory impact the US currency. Overnight, one of our favorite newsletter writers, Kiril Sokoloff, author of the popular 13D’s “What I Learned This Week” newsletter, framed this all-important question similarly: “The key question is whether the Trump administration wants a weaker dollar to boost US exports.”
His answer is “yes” and in addition to forecasting that the Fed will not hike three times in 2017 as the FOMC expects, he also notes that “given the fact that on a purchasing parity basis, the dollar is extremely overvalued versus the euro the yen and the British pound, it seems to us that the best strategy is to talk the dollar down” and adds that “based on several factors, we think the Trump economic plan may take a long time to get passed and the markets have gotten ahead of themselves. We may find the Fed unable to raise rates anytime soon. If unemployment keeps rising–recall that it has risen from 4.6% in November to 4.7% in December to 4.8% in January–then the Fed may find itself cutting interest rates before the year is over.”
Here is his full note explaining why he is bearish on the “most crowded trade in the world.”
Our views on the US Dollar.
In response to a reader letter, 13D founder Kiril Sokoloff explains our bearish take on “the most crowded trade in the world.
The following excerpt began as an email exchange between one of our clients, our chairman and founder, Kiril Sokoloff, and the global research team at 13D.
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“As the outlook for the US dollar is so important to investment and business decisions, I would like to have a deeper understanding about views of 13D and Kiril on the US dollar in respect to the following:”
- Bearish views on the US dollar are mainly attributed to Trump’s determination to have a weaker dollar against its trading partners with trade surpluses (i.e. Euroland, Japan, China) through tough trade negotiations. Are there any other factors behind the bearish views on the US dollar?
- Does this mean that the pace of US rate hikes will be slow and the magnitude of rate hikes will be mild? Is it because Trump will revamp all relevant statistics including job numbers and GDP growth so that there would be room for the Fed not to raise rates? Or will the widening interest rate differentials between US and other major countries not have a material impact on the US dollar exchange rate?
Below are insights from Kiril and our analyst team regarding the US dollar:
The argument for a stronger dollar is that Trump’s economic policies will strengthen the US economy. First, if a border tax is passed on imported goods, it is widely believed to cause the US dollar to strengthen anywhere from 20 to 25%, which could offset some or all of the added tax on businesses. Second, part of the tax plan is to allow US multinationals to repatriate the roughly $2 trillion they have offshore. It is unsure whether this is already in US dollars or other currencies. To the extent it is not in US dollars, bringing the funds back will strengthen the US dollar. Third, in the early 1980s, when President Reagan cut tax rates and boosted fiscal deficits, the US dollar became very strong and many observers are looking at that to repeat itself.
As you know, the world is much different now than it was in the early 1980s. At that time, we had the highest interest rates in the history of capitalism. Now we have the lowest interest rates in 5,000 years. Also, debt levels are much higher now.
The case for a weaker dollar rests on what is the best way to improve the trade situation with those countries that generate huge trade surpluses against America. Imposing an import tax on those countries would clearly bring retaliation for US exports. So, while Paul Ryan’s plan of a border tax might sound good to academics and theorists, we wonder whether it will be enacted. Some Senate Republicans have expressed skepticism about the wisdom of a border tax, raising more doubt about its ultimate passage. This is a very important consideration.
Nevertheless, the key question is whether the Trump administration wants a weaker dollar to boost US exports. Given the fact that on a purchasing parity basis, the dollar is extremely overvalued versus the euro the yen and the British pound, it seems to us that the best strategy is to talk the dollar down.
Also, we do not believe the Fed will raise interest rates three times in 2017. The Fed is under great scrutiny by the Republicans in Congress and many of them want to take away the Fed’s independence. It is interesting to note that the many speeches that members of the Fed were making up to the election have dropped dramatically as they realize it is in their best interest to stay quiet. (Interestingly, the Fed’s top financial regulator, Daniel Tarullo, unexpectedly submitted his resignation on Friday). Also, based on several factors, we think the Trump economic plan may take a long time to get passed and the markets have gotten ahead of themselves. We may find the Fed unable to raise rates anytime soon. If unemployment keeps rising–recall that it has risen from 4.6% in November to 4.7% in December to 4.8% in January–then the Fed may find itself cutting interest rates before the year is over.
As far as the euro goes everyone is bearish on it, and of course, it depends a lot on the French and German elections. With François Fillon likely out of the picture, we are now looking at Emmanuel Macron as an alternative to Marine Le Pen, who would be disastrous for the European Union and euro. When it comes to politics, it is very hard to make investment decisions because the electorate is very volatile in these times.
However, because of the universal bearishness on the euro and the crowded trade in the US dollar, we prefer to be long on the euro because everyone is on the other side of the trade. Furthermore, the recovery in European bank lending appears to be at a much earlier stage versus the US, which may help underpin a stronger euro. Already we are seeing that the EU economically is doing better than the US. And certainly, all the volatility that the Trump administration is creating cannot be good for US economic growth in the short-term.
Technical factors are another important consideration for the US dollar. For over a year, we have documented the many market reversals from deflation to inflation. The previous deflation market trends traded inversely to the dollar index. Unless the multi-decade inverse correlations no longer apply, the year-plus uptrends in the inflation-markets (many of which have advanced significantly) argue that the dollar is poised to decline.
Also, key long-term momentum indicators are now declining for USDJPY and USDEUR. These measures peaked over a year ago for the USD Index. Notably, “low-quality” currencies such as ZAR and BRL have appreciated strongly versus the dollar, which is an important clue that the dollar index is highly vulnerable to a sharp decline.