In a Nutshell: What’s Up With Our Dollar?

By Ken Herman

"Global shortages of most hard and soft commodities are coming at a time when domestic and global economic growth is accelerating, meaning that inflation is looking anything but 'transitory' as the Fed apparently wants us to believe."

Why has little attention been given to the rather sudden 3% exchange pullback for the dollar (versus the utilized basket of currencies)?  During the past 12 months the cumulative dollar value drop has been over 10%!  Currency exchange rates are moved by many factors, including politics, interest rates, speculation, and economic growth.  Two important factors, economic growth and exports, are directly related to a country’s domestic industry.  Some currencies, however, are heavily correlated with commodity prices.

Some Wall Street foreign exchange traders are attributing the greenback’s latest fall to specific commodity-linked currencies outperforming their European rivals less than the American dollar.  The powerful move of commodity prices since last December indicates most are now trading above their pre-pandemic levels.  Global shortages of most hard and soft commodities are coming at a time when domestic and global economic growth is accelerating, meaning that inflation is looking anything but “transitory” as the Fed apparently wants us to believe.

One of the main issues fueling the view that our upward price pressures are going to be sustained is the historic amount of central bank and government stimulus that has overheated America’s economic growth.  First-quarter gross domestic product (GDP) growth came in at 6.4%, which is stellar when one considers that the pandemic didn’t impact the economy until mid-March 2020 — near the end of 2020’s first quarter!

The Atlanta Fed GDPNow model estimates GDP growth of 11% for the current quarter! The takeaway in the Capital Markets is that the market isn’t buying the Fed’s narrative about “transitory” inflation – not when mega-tech stocks fade on blowout earnings while financial, transports, industrial, energy, and materials stocks rally.

Even as the 10-year yield has been trading between 1.5% and 1.6%, there has been a newfound reality check these past couple of weeks. Namely it is sinking in that interest rates may start to rise again following the current pause.  It is also thought that the Fed will have to start a conversation about tapering its amount of quantitative easing (currently $120 billon per month) in the face of $5.7 trillion in current and proposed government spending by the Biden administration (that should further fuel GDP expansion).

All this money pouring into the banking system and the economy comes at a time when the economy is already rebounding at a strong clip.  This scenario carries the risk of seeing bond yields pop higher.  This could trigger a move in the 10-year Treasury that would likely weigh on investor sentiment – which has been hoping for ultra-low interest rates “forever.”  Nevertheless, until that upward rate move happens the path of least resistance for stocks is higher.

A third leg in the dollar’s potential demise is the parabolic growth in the nation’s debt, currently sitting at roughly $28 trillion. Moody’s Analytics (in reports on the Jobs Plan and Families Plan to be paid for by increased taxes on corporations and wealthy households) has estimated a shortfall of $848 billion over 10 years for the Jobs Plan, as well as a $218 billion shortfall on the Families Plan. That’s over $1 trillion short!  Penn’s Wharton Business School calculates Biden’s two proposals would spend $5.2 trillion and only raise $3.4 trillion in the first 10 years, increasing the deficit another $1.6 trillion.

To say the Capital Markets are concerned is a significant understatement.  The bond market will bring a burst of debt supply, with the U.S. Treasury auctioning trillions of two-year, three-year, 5-year, and 10-year treasury notes, in addition to 20 as well as 30-year treasury bonds!  How the dollar may trade against this heavy new debt issuance will carry psychological weight for both the bond and stock markets.

With surging GDP growth, spiking commodity prices, and soaring debt loads, our dollar is at a technical inflection point.  The Federal Reserve has the power to step in to buy dollars to support the price.  Such an action by a central bank in the forex market is seen as a way to stabilize or increase the competitiveness of that nation’s economy; however, it also would send a very negative message – that the Fed is buying dollars to offset fears of debt-related significant devaluation.