Deutsche Bank Flip Flops On Dollar Again, Joins Bullish Wall Street Herd… Just As Dollar Slump Returns
Back on the night of November 3, when it briefly appeared that Trump was about to shock everyone and win the presidency again after winning Florida and Ohio, Deutsche Bank’s FX strategist George Saravellos, rushed to close out his dollar short position, saying that “with the US election outcome extremely uncertain” he changed his USD view and turning neutral as he “no longer sees a compelling narrative of dollar weakness into year-end for three reasons.”
However, just a few days later, on Nov 9, George flip-flopped (shortly after it emerged that Biden was the winner after all), and reversed on his call, saying he was turning short the dollar after all, and gave the following mea culpa for why he acted like a trader (investment horizon measured in hours instead of months) rather than a strategist:
Biden has emerged as the clear President-elect this weekend and the market is sending a strong message of looking through any remaining uncertainty. We were therefore wrong to close out our dollar short and we reinstate it. We believe the broad trade-weighted dollar has the potential to drop by another 3-5% into the end of the year with EUR/USD convincingly breaking 1.20, USD/JPY reaching 100 and USD/CNH 6.40, as highlighted by our Asia colleagues on Friday. It all boils down to three drivers: i) The unwind of the Trump dollar risk premium. ii) The return of carry and the dollar as a funder; iii) More virus divergence ahead of us.
Well, fast forward another two months when the Deutsche Bank strategist has flip-flopped again and in a note published overnight, he said that Deutsche Bank is now “tactically neutral” on the U.S. dollar, closing his latest flip-flopped call that the USD would decline broadly this year, and is shifting to a short yen position. This is what he said:
One year on, and humankind is nearly turning the corner on the Coronavirus. But markets are also nearly there in pricing this in and we are making some important adjustments to our currency views.
First, having been vocal dollar bears last year we are turning tactically neutral on the broad USD and even like buying the dollar against the yen. The Democratic win in the Senate should lead to a huge US fiscal stimulus over the next few months and allow the market to anticipate earlier Fed tightening, while the US is running ahead of Europe in vaccinating its population. Dollar weakness is at the upper bound of historical experience at this stage of the recovery and some consolidation is therefore in order. The second change in our Blueprint is in Emerging Markets. We were very positive on EM FX last September but now see more scope for differentiation: we prefer concentrating on a narrower set of currencies with more positive fundamentals as well as relative value trades. In all, we are neutral on EUR/USD in coming months, we are bearish on the trade-weighted yen and prefer rotating CNY longs to a basket.
Neutral on the euro, but turning bearish on the yen
The Georgia senate election has led to a sharp repricing in US yields and already prompting questions on whether the dollar downtrend is over. We think it is too early: as long as the US yield curve remains steep, there is strong historical precedent for the dollar to stay weak. The US current account is set to deteriorate significantly and FDI outflows are picking up. Further declines in global uncertainty should put additional pressure on the dollar. Still, the USD is at the extreme end of prior downtrends at this stage of the economic cycle, the market is sitting short and a Biden fiscal stimulus can bring material upside surprises to US growth in coming months. With few catalysts on the European side of the Atlantic, we see EUR/USD consolidating in coming months but would be looking for an opportunity to buy once these dynamics have been priced in. The JPY should have more scope to weaken, and we are turning bearish on a trade-weighted basis. Persistent portfolio outflows and an environment of rising yields, commodities and equities should be even more negative for the yen this year.
The big picture for the dollar is still negative
Many are focused on global reflation dynamics, but the most important driver of the dollar over the last few years has been broader: global uncertainty, ranging from Brexit to trade wars and COVID. The higher the uncertainty, the stronger the dollar – and vice versa. Between vaccines and a Biden administration, the global uncertainty premium looks set for a dramatic decline in 2021. If uncertainty were to return to pre-Trump levels there is another 4-5% in dollar weakness to go, but the dollar has already priced in a good deal so some consolidation looks likely
Beyond the cycle, big moves in the dollar have always been accompanied by turns in the US basic balance. All three key components of the US external accounts are now showing important signs of deterioration.
The “quality” of portfolio inflows is declining via a shift away from bond financing, and FDI flows are deteriorating helped by a notable rise in US investment abroad. Our M&A monitor shows that net US acquisitions are at a near twenty-year high, helped by extremely rich US equity valuations. The current account deficit is also widening, with the December trade numbers posting the biggest deficit on record. Further significant worsening is likely on the back of Democratic fiscal stimulus.
But now it’s time for some consolidation
It is notable that the dollar trends very strongly after the end of recessions. The trend itself is a function of the Fed policy stance: the 1970-90s saw the Fed maintain elevated real rates to push down inflation even during recessions. The 2000s have seen much more aggressive Fed easing, with the dollar weakening for at least two years after the last three recessions. The current move is at the upper bound of previous dollar downtrends that have typically been followed by some lengthy consolidation.
This should coincide with a window to reprice US growth as Biden stimulus kicks in, as well as a faster vaccine rollout in the US compared to Europe. The change in fiscal outlook over the last few weeks has been dramatic, with the US now set to benefit from the most positive fiscal impulse this year compared to tightening before.
As far as the Fed goes, we have documented extensively that the US curve matters the most for the dollar, rather than the outright level of yields. So long as the US curve remains steep, the environment should remain negative for the dollar.
It is important to remember that the dollar weakened in the 2013 taper tantrum once the Fed brought front-end yields under control
There is more but you get the idea. The bottom line is that the past 2 months have seen 3 Deutsche Bank FX reco changes (or flip flops):
That said, it wasn’t just Deutsche Bank, and as so often happens, Wall Street moved as a herd with the result a slew of bearish dollar trade recos (via Bloomberg):
TD Bank (Mark McCormick, others, Jan. 12 report)
- “The Blue Ripple should reinforce a backup in U.S. yields, helping cap USD downside in the short-run”
- The strategists still expect a weaker greenback this year, with the environment turning dollar-negative again toward the second quarter as markets price in the progress of vaccination campaigns that would contribute to a global recovery
- They still recommend selling EUR/USD at 1.2175, with a target of 1.1800
Morgan Stanley (Matthew Hornbach and others, Jan. 9 report)
- They too dropped their expectations of near-term dollar weakening: “We turn neutral on the USD amid rising U.S. fiscal stimulus odds and crowded USD sentiment,” Hornbach and colleagues wrote. Meanwhile, they’re looking “for signals on when to turn bullish”
- The prospect of more stimulus and of the Federal Reserve normalizing policy “have the power to dispel a widespread USD-negative assumption of low U.S. yields,” the firm said. “With focus shifting to new fiscal policies in the U.S., we think both U.S. real yields and the U.S. dollar are in a bottoming process”
Scotiabank (Shaun Osborne and Juan Manuel Herrera, Jan. 12 report)
- Dollar rebound “may extend a little more in the near term, given rising yields, the accumulation of short USD positioning, seasonality” and other factors
- On Tuesday, the risk environment was “not unequivocally bullish” even as firmer energy prices and modest demand for gold helped commodity currencies outperform somewhat
Higher U.S. yields seemed incompatible with the softer USD tone during the NY trading session
HSBC (Dominic Bunning, others, Jan. 11 report)
- HSBC is skeptical on the impact of the latest rise in U.S. yields on currency moves; Despite the recent spike in U.S. 10-year yields above 1%, Group-of-10 currencies are still more aligned to risk sentiment than to relative-rate differentials, the strategists said
- For every USD-based pair that the team tracks, except USD/JPY, “the most recent relationship between the currency and risk appetite as measured by the S&P 500, is stronger than the relationship between the relevant 2y yield differential”
- “For rates to matter more for FX, either the level needs to be even higher or the front end needs to start moving more”
JPMorgan (Meera Chandan, Jan. 11 report)
- One of the firm’s models has turned more bearish on the dollar, standing at 40% short USD compared to 25% in late November
- The focus remains on growth, which faces competing tensions. But “momentum in the global recovery has been strong”
- “Our growth signals based on economists’ forecasts are also still suggesting short USD exposure–currently max short the dollar”
Of course, it would be pure poetry that on the day virtually everyone on Wall Street turned bullish on the dollar… that the Bloomberg dollar index, after several days of gains, resumes its sharp moved lower…
… and in a few days all of the abovementioned banks scramble to flip-flop too.
Tue, 01/12/2021 – 15:05