Does the U.S. Government Want a Strong or Weak Dollar?

by the Curmudgeon with Victor Sperandeo

U.S. Treasury Secretary Steven Mnuchin moved markets this week with his comment that a weak dollar benefits American trade. That remark helped plunge the U.S. currency to a three-year low and touched off a flurry of speculation about the Trump administration’s economic plans. It also sparked a rally in gold, silver and commodities (which are priced in dollars).

“The dollar is one of the most liquid markets,” Mr. Mnuchin said. “Where it is in the short term is not a concern of ours at all. Obviously, a weaker dollar is good for us as it relates to trade and opportunities. But again, longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency, in terms of the reserve currency.”

“I thought my comment on the dollar was actually quite clear yesterday,” he told reporters hours before Mr. Trump arrived in Davos for the World Economic Forum. “I thought it was actually balanced and consistent with what I’ve said before, which is we’re not concerned with where the dollar is in the short term, it’s a very, very liquid market, and we believe in free currencies. And that there’s both advantages and disadvantages of where the dollar is in the short term. Let me say, I thought that was clear.”

Mnuchin said on Friday he was not trying to talk down the dollar and his comments earlier this week were taken out of context, according to an interview with CNBC.

"I made the comment two days ago in a press gaggle in the morning. What I said was actually very even-handed and consistent with what I said before," Mnuchin told CNBC from Davos, Switzerland. "I was not trying to move the dollar."

“Treasury Secretaries normally are highly disciplined when they speak on the dollar to ensure their words are treated seriously when they want to signal policy shifts or to build confidence in challenging economic moments,” said Gene Sperling, who served as the top economic adviser to Presidents Barack Obama and Bill Clinton. “This type of seemingly off-the-cuff and politically careless back and forth just erodes that type of authority when it will be most needed,” he added.

James Paulsen of Leuthold Group Weighs-In:

In our view, recent weakness in the U.S. dollar reflects growing inflation expectations which should not be considered “good news” for the financial markets. The accompanying chart overlays the U.S. dollar index (blue solid line) with the embedded inflation expectation in the 10-year U.S. Treasury TIP Bond Index. The bond market’s inflation expectation is shown on an inverted right-side scale so that as the dotted brown line declines inflation worries are rising.

Rising inflation destroys the relative value of the dollar. Clearly, throughout this recovery, the U.S. dollar has been driven by inflation expectations. The dollar did not surge in 2014 because the Fed or the bond market raised interest rates. Rather, it increased in value because inflation expectations declined from about 2.3% to about 1.2% enhancing the dollar’s real purchasing power. Since last summer, inflation expectations have increased to a new three-year high above 2.08% coinciding with the U.S. dollar recently breaking to a fresh three-year low.

We expect inflation evidence and inflation worries to keep climbing this year and that implies further U.S. dollar weakness.

A U.S. dollar trending (collapsing?) lower is likely to bring much more pressure to a 10-year bond yield which is still below 2.7% and an S&P 500 P/E multiple based on trailing earnings per share of about 23x.

Victor’s Comments:

The Trump Administration wants the U.S. dollar down. Let’s look at what happened in the late 1970s to inflation and interest rates when the dollar tumbled.

From June 1976-77 through 1980, the U.S. dollar index declined -20.9% (DXY went from 107.05 to 84.65).

· The CPI during that time period was + 9.60% compounded.

· Fed funds went from 5.25 to 14.00% and other interest rates also rose sharply.

In other words, inflation was accelerating even while interest rates were rising during the dollar’s decline. Normally, one would expect the dollar to increase in value on a strong rise in rates. But that didn’t happen!

Also, U.S. GDP rose strongly, but most of it was due to inflation. From 6/76 to 6/80, nominal GDP (unadjusted for inflation) compounded at +10.8% annual rate. Yet “real GDP” only increased by +3.09% annually!

This is the fundamental reason the dollar will decline: the Trump administration wants it down. The markets are predicting that inflation is finally going to spike upwards!

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Good luck and till next time...

The Curmudgeon
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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