Why the US Dollar Rally Is About to Die

Why the US Dollar Rally Is About to Die

Just after I warned on Wednesday that the European Union could impose tariffs on imports of US energy, the Trump card came into play.

The EU and the US declared ceasefire to the trade war and a return to the negotiating table. Markets will like this.

Part of the new agenda is Europe making an early commitment to import more US natural gas once America has the export capacity in place.

Take note of one thing in particular:

For all the rhetoric about Trump’s cosy relationship with Russian President Vladimir Putin, the US president is doing a fine job of trying to undercut the Russian export market in Europe. Already Trump has courted Poland and the Baltic states with US LNG.

Earlier this month Trump also criticised the German government for its support of the Nord Stream 2 pipeline that’s due to run from Russia to Germany via the Baltic Sea.

A country like the US can afford to lose energy exports because it has such a range of diversified industries. But oil and gas accounts for much of the Russian economy. It’s more than a trade battle on this front — national survival is at stake for Putin.

But it gets worse for Russia.

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The new prime minister of Georgia is reaffirming the commitment of the country to join the NATO alliance.

This would put a strategic ace into the hands of the West and mortal terror into the minds of strategists in Moscow. Georgia is directly on Russia’s southern flank. The entire western border of Russia is being stacked with rival military power.

No doubt Trump continues to pressure European nations to buy more equipment from the big US weapons manufacturers as well. Few of the EU countries meet their NATO commitments to spend 2% of GDP on defence.

There is a shrewd method to Trump’s madness. That money will flow into the US stock market. The going is already pretty good.

One example is Lockheed Martin Corporation [NYSE:LMT]. It just announced its second quarter earnings results. It beat expectations and raised its 2018 forecasted revenue by over US$1 billion.

Then again, Lockheed is not alone in smashing results out of the park right now. The majority of US companies are reporting fantastic results.

One reason for that is well known: the Trump tax cuts that dropped the corporate rate to 21%. That’s boosted earnings across corporate America.

But there’s naturally an opposite effect. That money is now not going to the US Treasury. The New York Times reports that tax revenue is at a record low and the federal deficit is now rising faster than previously predicted.

This might seem an obscure observation. However, it’s vitally important. The market is incredibly bullish on one thing in particular at the moment: a rising US dollar.

The assumption is that rising interest rates in America will keep taking the currency higher. As a result, some emerging market currencies and commodities have come under a lot of pressure lately. That’s because a rising USD works against these currencies.

However, always be prepared to take an opposing view.

The correlation between interest rates and currency moves is not as clear-cut as many would have you believe. After all, for a long time, Australia had higher rates than the United States, and yet the Aussie dollar fell relative to the USD.

The mammoth US government deficits have high potential to weaken the US dollar. Also of note is that, despite Trump’s best efforts, the Chinese trade balance with America was at a record high in June.

The biggest implicationfor us here in Australia is in regards to the effect this could have on commodity pricing.

Oil, which is priced in US dollars, is one example.

It’s expensive enough as is, but spare a thought for Indians, Turks and Argentinians. Their currencies have been clobbered this year, which makes buying oil even pricier.

A weakening USD — should it occur — would help support oil demand in emerging markets. It would also make commodities more attractive as an inflation hedge for US money managers.

The debate around US government debt is going to come into sharp focus again after the northern hemisphere summer holiday period finishes up at the end of August.

The current spending bill sustaining the US government is due to expire in September. That puts the threat of a federal shutdown in play again.

The Democrats could play hardball here because midterm elections are taking place in November. A bit of legislative chaos won’t help the Republicans.

If the US dollar starts shedding value, expect to see higher US dollar commodity prices.

I keep hammering the same point: The time to be scooping up raw material stocks is now.

Regards,

Callum Newman Signature

Callum Newman,
Editor, The Daily Reckoning Australia