The dollar bull run is not over

Text size

About the Author: Stephane Miran is co-founder of Amberwave Partners and served as Senior Economic Policy Advisor to the U.S. Treasury, 2020-21.

With the Euro ‘breaking the ball’ to trade below par, it may look like the US Dollar has traveled a lot and should be close to a top. However, the structure of global credit markets could give it new legs.

October’s price action was replete with tales of a Federal Reserve “pivot,” whereby the Fed would return to its previous dovish stance on inflation, supporting asset prices. However, the market’s response to the idea of ​​such a policy move undermined its premise: if the Fed were to really pivot before a real economic slowdown materialized, the rush to support demand would drive stocks higher. and energy commodities, leading to further inflation. pressures. So it’s no surprise that Fed Chairman Jay Powell last week doubled down on monetary tightening and reiterated that policy hadn’t yet become tight enough to bring inflation under control.

While kingpins are hard to come by in DC, they’re flourishing overseas. Andrew Bailey, Governor of the Bank of England, said on Thursday that rates “are likely to rise less than what is currently priced in financial markets.” The Bank of Canada surprised by increasing by 50 basis points instead of 75. The Royal Bank of Australia only increased by 25 basis points at its last meeting. And the president of the European Central Bank said: “we are not the same and cannot progress at the same pace” as the Fed. How could the pivot happen anywhere but the Fed?

One answer lies in the structure of the home loan. US households are borrowing heavily in 30-year fixed rate mortgages. If a household borrows at 3% for 30 years and mortgage rates go up to 7%, they continue to pay the same rate as long as they stay in the house.

Elsewhere, many households borrow on varying terms. For example, in Norway almost all recent mortgages are adjustable; in Australia, about three quarters; in Japan, about two-thirds; and in the UK about a sixth. Households with variable rates can see their monthly payments increase very quickly.

While some countries apparently have low shares of variable rate mortgages, sometimes that’s because “fixed rate” means something completely different there. In the UK and Canada, for example, fixed rate mortgages are usually only fixed for terms of two or five years, after which they reset to a new fixed rate for the next two or five years. Unlike U.S. households, at least a fifth of these borrowers will see their interest rates assessed higher this year in these countries, which can result in significantly higher monthly payments, although how these increases are calculated varies from country to country. country to another.

With inflation already eroding real incomes, higher monthly payments will put additional pressure on households, leading to a considerable economic slowdown.

Monetary tightening is therefore much more powerful in these countries than it is in America. A 1% hike by the Bank of England weighs much harder and faster on the UK economy than a 1% Fed hike on the US economy. Ten years ago, Mark Carney, then Governor of the Bank of Canada, spoke of trade interdependence and “limits to divergence” as justification for following the Fed. There are now limits to convergence. Other central banks in developed economies simply cannot keep up with the Fed in the thin air of higher rates; the Fed can climb higher than all of them.

This new currency divergence could propel the dollar higher as US asset yields widen their advantage over other countries. And a probable global recession induced by coordinated monetary tightening will generally hit the rest of the world harder than the United States, pushing other currencies lower. With these drivers of US dollar strength, the dollar’s bull run may have more room, and investors and policymakers should make contingency plans for that outcome.

Guest comments like this are written by writers outside of Barron’s and MarketWatch newsroom. They reflect the views and opinions of the authors. Submit comment proposals and other feedback to ideas@barrons.com.