Is The Real Dollar Pain-Trade Lower?
Although I am sure they were some traders advocating shorting the US dollar into the Trump bump, they sure seemed few and far between (apart from this badass cat who nailed the trade and is now covering into the USD weakness).
In fact, when I think about the opinions from the “cool kids” over the past six months, I can only recall all-out-bulls, or unsure fence sitters. Name me a big-name US dollar bear pounding the table – none spring to mind.
And in the heyday period following Trump’s election, the US dollar bullishness was downright exuberant.
“Super dollar bull market” was a recurrent theme amongst the myriad of bulls who were convinced the US dollar was headed to the moon. Whether it was due to Trump’s supposed superb business acumen, or the acceleration of the emerging market USD debt obligation payback vicious circle, all these bulls had their own reasons why greenback would continue to appreciate.
Well, how did it turn out?
A complete dud. Trump’s inauguration proved to be the top, and it has been nothing but downhill since then. I am actually quite mad at myself, fading this consensus trade proved to be one of the greatest trades of 2017 (and yet another example of how in this day of limited alpha, the best trade is fading the crowd).
Yet the interesting part of this extended move? No one is getting excited about it.
I pulled up my composite speculative positioning of CME currency positions, and it is pretty well zero. US dollar specs are almost as flat as your uncle’s drunken campfire singing at a cottage long weekend.
Recently, two terrific, must-follow, twitter traders were discussing this situation. 13D Research, author of the terrific What I learned this week, first made a comment about the possibility of this US Dollar move continuing.
But then, Luke Gromen, who pens Forest for the Trees, chirped in with a comment I felt was especially apt.
Luke is right. No one is talking about this US dollar move continuing. I get the sense it’s actually the opposite. Most traders are still worried about the potential for the US dollar bull move to resume. If they are long any currencies, they have one finger on the sell button.
I get it. It’s tough to forget the pain from the relentless US dollar rally of the past 3 years.
When I was thinking about this situation, my mind wandered back to a MacroVoices interview with Tian Yang from Variant Perception. I had never heard Tian before, and I must say, I enjoyed his analytical approach immensely. But his comment about Morgan Stanley’s Stephen Jen’s smile theory really struck home. According to Jen, the US dollar does best when the US economy is really strong, or really weak. That immediately made intuitive sense. When the market is expecting US outperformance, the US dollar goes up because of higher rates and flows rushing into the US. During periods of economic stress, the reserve currency goes up as debt is paid down and US dollar credit is destroyed. But that has to leave a whole bunch of time when the US dollar goes down.
From 2014-2016 we were in the US outperformance period of the smile. That enthusiasm about US economic performance climaxed with Trump’s election and the fairy dust dreams about the new President’s economic prowess.
There were some pundits who believed we would switch from the positive part of the smile, to the other side, as the Fed hiked too fast, and caused a market disruption. But isn’t it more likely that this transition from one side of the smile to the other takes some time? Wouldn’t a period at the bottom of the smile be more probable?
And going back to Tian’s interview, here is a chart that shows the US dollar’s performance versus real rate differentials.
As you can see, the US dollar was way over its skis last year. And 13D’s forecast of a continued slump is by no means out of the realm of possibility to correct the difference between real rates and the US dollar.
(As an aside, if you want the full Variant Perception’s package from the interview, I uploaded it to my server and you can download it here. And while you are at it, make sure you head over the MacroVoices and help out Erik and Patrick by signing up to their weekly email. They produce this terrific show each week for free, and the size of their member list helps in attracting great guests. They won’t spam you, and not only that, it is chock full of great research pieces like the Variant Perception presentation.)
Today we have both the ECB and BoJ meeting. Could some renewed dovishness cause the US dollar to pick itself off the mat and rally a little? For sure. The US dollar is oversold and due for a bounce.
But a little part of me wonders if everyone is looking for a US dollar rally to sell into. I don’t yet know what I am going to do. I too, am looking for a better entry, but that makes me just another mope. Sometimes the best trades are the ones no one believes in, and which do not offer a clean, easy entry. Luke Gromen is right when he says there isn’t a soul alive who thinks the DXY could fall below 80. Don’t forget that markets often go to points least expected, and where they hurt the most participants. With the world massively overweight US financial assets, I almost wonder if the real US dollar pain trade is lower.