The market expects the Federal Reserve to raise rates seven times this year but this hawkish outlook is getting priced into the market but there will be no big correction in the USD in our view.
Because the USD is the global reserve currency and tends to do well when the global economy contracts…
Global Growth Contracting Bullish the USD
We have the highest inflation in 40 years and it’s unlikely to moderate soon.
Central banks around the world including the Fed will raise interest rates which are coming against a background of slowing global growth.
Global growth was slowing even before Russia invaded Ukraine and the invasion has made the global growth outlook worse.
The Fed is not only going to raise rates they are also going to reduce the balance sheet.
Yesterday Fed Vice Chair Lael Brainard noted that the reduction in the balance sheet could come as soon as June Brainard further noted that balance sheet reduction is the equivalent of “two to three additional rate hikes”.
The reason contracting global growth is bullish for the USD is due to the stimulus being withdrawn and global economic funding…
Loan Contraction Expansion Impact on the USD
The USD is the global reserve currency and dominates global financial transactions.
Although the United States accounts for one-quarter of global economic activity, over half of all cross-border bank loans and international debt securities are denominated in the USD.
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In terms of banks in the eurozone and the UK, they will grant more loans in USD than in their own currencies.
Why is this important?
Wen we have global expansion loans granted in USD are exchanged for other currencies depreciating the USD.
On the other hand, When we have a global economic contraction, fewer loans are granted and existing loans are called back and these loans are converted back to USD.
Stock Markets To Fall and Firm the USD?
The reduction of stimulus is heavily bullish for the USD as it takes dollars out of the financial system. The end of stimulus and reduction of the balance sheet is also bearish for stocks.
The stimulus was one of the main reasons the SP500 rallied from its COVID lows by 100% to its recent highs.
With stimulus gone, rate hikes coming, and growth slowing, the chances of a correction in stocks are high, and if stocks fall, this is bullish for the USD on its safe-haven status.
The market thinks the Fed is unlikely longer term to continue with its hawkish stance and has been buying dips in the SP500 which in our view will end…
The big long-term fundamentals are bullish of the USD, on the chart we can see the USD is in a firm uptrend and we think the move up has further to run dips are buying opportunities.
Not investment advice. Past performance does not guarantee or predict future performance.