The dollar 'should' be on the rise and it's not

Outlook:

The euro’s resilience only days before the ECB policy meeting implies the market is putting its money on Draghi withholding one or more of the easing mechanisms. The ECB did this is December and the euro rallied like a banshee. Draghi’s choices include increasing the negative rate by 10 bp or maybe 15-20 bp. This one we are likely to get. Another option is tiered rates. A third option is raising the amount of QE and a fifth option is extending the QE program another six months. A sixth option is a long-term repo.

Of these, raising the amount and extending the duration of QE are probably the strongest, but analysts seem to think all we will get is a deeper negative deposit rate, which is not exactly producing results (yet). Draghi must be torn between counselling patience and delivering a bit hit—all six, all at once. One issue that is sort of funny—BBK chief Weidmann is a non-voter this time. His is the loudest voice against QE and all its cousins. Perhaps Draghi feels the need to hold back on some measures to avoid looking like the mouse playing while the cat is away.

And yet the inflation problem remains a problem. Bloomberg notes the German inflation rate dropped to minus 0.2% in Feb, the weakest figure in more than a year. Eurozone inflation was also minus 0.2%. Surely stimulus is in the cards.

But stimulus is not working so far. European inflation and inflation expectations are not rising. Activity is not being boosted. The question must be uppermost in Draghi’s head—what does it take? Logically, he should throw everything into the pot, saving nothing in reserve. The time for reserves is past. He must avoid looking desperate, implying he will have to lean on fiscal matters if the all-in initiative also fails.
The bigger issue is the linkage between commodity prices and equity indices, and between commodity prices and currencies. We expect the commodity producing currencies to deliver a knee-jerk reaction, although both the AUD and CAD surprise quite often on other economic data. The presumed correlation between the dollar and oil is toxic. For one thing, it’s illogical. For another, it’s not a dead cert—we had periods, granted a long time ago, when a rise in oil dragged the dollar higher, not lower.

And worst of all, as Goldman says to great attention today, the recent rally is not likely to last as long as inventories are so high. This applies to many things other than oil—copper being the No. 1 industrial metal in play. The last time we remember so much attention on copper was 2004, just as China was getting started. Goldman says the seeming recovery we have witnessed over the past few weeks is doomed to reverse unless China can deliver demand for commodities.

The thesis that when China sneezes, the world catches cold is an article of faith rather than a proven fact. It’s not a bad theory and we certainly saw the China effect in early January and before then, last August, when the world’s stock markets tracked the Shanghai down. Goldman has two strong factors supporting its thesis—supply and demand. Commodities are in oversupply. China may be delivering lower demand than producers expected when they produced the oversupply. But maybe the producers produced too much without having a sane and reasonable estimate of demand. Maybe they had good estimates and just didn’t care about oversupply as long as the lowest price is higher than their marginal cost—vide fracked oil.

What we object to is Goldman naming a single player, China, as holding all the cards. It reduces a complicated multi-player process to a single entity and a political one, at that. This can’t be healthy. The implication is that the non-Commie world needs to get together and start strategic stockpiles of everything, especially industrial metals, to offset the effects arising from the actions of the single player. The US has a strategic stockpile of various industrial commodities (medicines, too) but it’s hardly a major player.
We already have global strategic stockpiles of oil and gold, and look how well that has worked out. Bottom line, if China is running the show and having such a monumental effect on everybody’s markets, is this how we want the world to work?

Don’t tell Bernie.

And here comes the next tsunami. Overnight, the terrible drop in Chinese exports and the trade surplus drove the Shanghai down over 3%, but in the last few minutes of trading, according to Bloomberg, massive buying in two state companies reversed the move. The Shanghai closed up 4.05%. Bloomberg is not shy about naming intervention when it smells intervention and does not name intervention this time, but let’s remember the last two times the Shanghai had a melt-down. Among other things, we saw a badly designed and incompetent state response. Oh, my.

As for the much-touted divergence trade, it ain’t happening—again. The dollar “should” be on the rise and it’s not. One explanation is that the divergence trade already pushed the dollar too high and now we are getting “sell on the news.”

Another explanation is that nobody has any faith in central banks anymore, the Fed least of all. After all, Japan has negative rates now and the yen is going up, not down.

And a third idea is that money has gone out of fashion and now we all prefer gold, not because of the usual inflation scares but out of fear that the guys in charge are just as clueless as the guys in charge in China. See the Bloomberg chart. This can be interpreted to mean equities are already fully priced (even if they never are) or that demand for equities is much reduced by the linkage to China and bunch of doddering, ideology-addled politicos. The West is in thrall to the Commies! We don’t buy this one for a minute. But you must admit it’s an interesting chart.