The $9 Trillion Short That May Send the Dollar Even Higher
Investors speculating the dollar rally is fizzling out may be overlooking trillions of reasons why it will keep on going.
There’s pent-up demand for the U.S. currency that will underpin years of appreciation because the world is “structurally short” the dollar, according to investor and former International Monetary Fund economist Stephen Jen.
Sovereign and corporate borrowers outside America owe a record $9 trillion in the U.S. currency, much of which will need repaying in coming years, data from the Bank for International Settlements show.
In addition, central banks that had reduced their holdings of the greenback are starting to reverse course, creating more demand. The dollar’s share of global foreign reserves shrank to a record 60 percent in 2011 from 73 percent a decade earlier, though it’s since climbed back to 63 percent.
So, the short-term ebbs and flows caused by changes in Federal Reserve policy or economic data releases may be overwhelmed by these larger forces combining to fuel more appreciation, according to Jen, the London-based co-founder of SLJ Macro Partners LLP and the former head of currency research at Morgan Stanley.
“Short-covering will continue to power the dollar higher,” said Jen, who predicts a 9 percent advance in the next three months to 96 cents per euro. “The dollar’s strength is not just about cyclical factors such as growth. The recent consolidation will likely prove to be temporary.”
Most strategists and investors agree on the reasons for the dollar’s advance versus each of its major counterparts during the past year: the prospect of higher U.S. interest rates while other nations are loosening policy.
Bloomberg’s Dollar Spot Index, which tracks the U.S. currency against 10 major peers including the euro and yen, has surged 20 percent since the middle of 2014. The gains stalled recently, sending the index down more than 3 percent in the three weeks through April 3, as Fed officials tempered investors’ expectations about the pace of rate increases.
Jen isn’t the only one who thinks short-dollar positions will cause the rally to extend.
Chris Turner, head of foreign-exchange strategy at ING Groep NV, sees the dollar surging through parity with the European currency by mid-year, from $1.0586 per euro as of 12:11 p.m. in New York. He said gains will be spurred by bonds from Germany to Ireland yielding below zero.
“Central banks are re-accumulating their dollar reserves and low, or negative, bond yields in the euro zone will probably speed up that trend,” said London-based Turner, whose bank topped Bloomberg’s rankings for the most accurate currency forecasts in the past two quarters.
Not everyone thinks the dollar will keep on climbing. David Bloom, global head of currency strategy at HSBC Holdings Plc, said in a report that the effects of policy divergence have run their course and that the greenback rally “will stall as the market demands: tell me something I don’t know.”
Billionaire Bill Gross of Janus Capital Group Inc. has meanwhile been betting on U.S. Treasuries against German bunds on the basis that the spread between American and European interest rates will narrow. He called his bet “the trade of the year.”
Adrian Lee, whose eponymous investment company oversees more than $5 billion, does expect the dollar to keep strengthening and points to monetary policy as the biggest driver as the tightening bias of the Fed contrasts with a European Central Bank that’s expanding the money supply.
“The dichotomy between Europe and the U.S. is most interesting,” said Lee, chief investment officer at Adrian Lee & Partners, which has offices in London and Dublin. “If you ask where our strategy would be in a year’s time, we can easily have a forecast of the euro well below $1.”
He also sees another structural factor that’s underpinning the dollar: the U.S.’s shrinking current-account deficit.
The decline in oil prices — even with the shale-gas revolution, the nation is still an importer — has helped the U.S. reduce its trade shortfall to 2.3 percent of gross domestic product, according to data compiled by Bloomberg. That’s down from a record 5.9 percent in 2006.
For Jen, the rise in dollar-denominated debt across the globe is key. The $9 trillion owed by borrowers outside the U.S. has surged from $6 trillion at the end of 2008 — when the Fed cut its benchmark interest rate to near zero, making it cheaper to issue in the currency.
Russian gas producer OAO Gazprom, Spanish phone company Telefonica SA and ArcelorMittal, the world’s largest steelmaker, have each raised about $12 billion in the U.S. currency since then, data compiled by Bloomberg show. France and Sweden are among the biggest sovereign issuers, borrowing more than $100 billion between the two.
Some of that will need to be repaid even if the remainder will be rolled over. And debt that will eventually be refinanced needs servicing in the meantime.
“After years of accumulating a huge amount of debt in dollars, borrowers will need to figure out how to repay” given the currency’s recent gains, Jen said. “People will either repay early or start hedging actively. There’ll be huge demand for the dollar that is much more than what’s consistent with growth or interest-rate differentials.”