Superdollar, Euro parity and the GCC

The Superdollar trend will have a huge macroeconomic impact on the GCC in 2015-16, exactly as it did in 1997-99.

The US May payroll was 280,000, at least 60,000 above consensus. This means monthly job growth in 2015 has averaged well over 200,000 and, if current trends continue, the US unemployment rate will be below five per cent by September. At this point, the constitutional logic of the Federal Reserve’s dual mandate will force even the dovish Dr Yellen to begin the first interest rate tightening cycle since 2006. The “regime shift” in the monetary policy of the world’s central bank will send seismic shock waves across the world financial markets. Stock markets will fall. Liquidity will vanish. Property bubbles will burst. Leveraged balance sheets will be punished. The financial chickens (demons?) of the post 2008 easy money era will come home to roost.

Even though President Obama allegedly said that a strong US dollar is a problem for the US economy (yet another policy error from the White House as the US Treasury is committed to a “strong dollar” policy), the fact remains that the world is in the early stages of a strong US dollar trend that will transform markets, economies and investing strategies. This “strong dollar” trend is reminiscent of Bill Clinton’s second term. The US Dollar Index has risen 20 per cent since May 2014. It is no coincidence that US dollar strength has correlated almost perfectly with a collapse in metal and crude oil markets. Does Obama’s anti-dollar comment in the Bavarian Alps have policy significance for the Yellen Fed? Absolutely not. The US central bank is independent and immune from Presidential interference. The US is not an export driven economy like Germany or China, Australia and Canada. However, a stronger dollar slashes US corporate growth and is a deflation shock for emerging markets. This means an overvalued Wall Street, at 18 times earnings, is in deep trouble. It is also not prudent to invest in emerging markets during periods of a Superdollar trend.

After all, the Mexican, Russian, Turkish, South Korean, Thai and Indonesian sovereign debt crises all happened in the late 1990s. The most dramatic event in international finance in the past year was the epic collapse of the Euro, from its 1.40 levels against the US dollar in early 2014 to 1.13 in mid June 2015. Foreign exchange is about relative value, relative economic growth and interest rate spreads, relative monetary policy stances between two central banks and relative inflation rates. Every one of these criteria dictates more upside in the US dollar’s value against the Euro. US economic growth could exceed three per cent while Europe, despite German and Spanish GDP optimism, remains mired in deflation. The Yellen Fed will raise interest rates at the September FOMC while the Draghi ECB will have to accelerate bond purchases. Historically, the US dollar appreciates against the Euro in the early stages of Federal Reserve tightening cycle and a consumer led US recovery.

Since May hourly earnings were up 0.3 per cent, any increase in US inflation and wage growth will only accelerate US dollar strength. Greece’s leftist/populist Syriza party and the population’s unwillingness to submit to an austerity diktat is a source of systemic risk for the Euro, as is the Kremlin’s annexation of Crimea and proxy war in Ukraine. Spain’s populist Podemos threatens the post Franco two party political consensus. The US banking system has been restructured and recapitalized after the trauma of Lehman/2008-9 credit crisis, the European banking system, as Deutsche Bank’s black holes attest, is still a financial black hole. The balance of risks suggests the Euro could well fall to 1.02 or even parity by December 2015. The plunge in the Euro in 2014-15 has created its own dynamic. Asian and Gulf Arab central banks are sitting on huge losses in Euro reserves that were meant to “diversify” from the US dollar. Global bond funds are fleeing the Euro. The ECB will react to deflation risk by aggressively easing its monetary policy (“shock and awe” QE on the Japanese model. This means reducing the Euro’s appeal as a funding currency.

The Superdollar trend will have a huge macroeconomic impact on the GCC in 2015-16, exactly as it did in 1997-99, when crude oil plummeted to $10 and GCC stock markets entered into major bear markets. Since the GCC currencies are pegged to the US dollar, any Fed tightening cycle means higher interest rates in the GCC. Since the strong dollar has coincided with a 40 per cent fall in Brent crude from its June 20 peak, higher interest rates during a time of $300bn in lost petrocurrency revenues is a double whammy deflation shock for regional asset markets – equity, debt and property.

Tourist economies like Dubai have also been hit by the crash in the Russian rouble and Western banking sanctions on Russia. Property prices in Dubai have fallen by 20 per cent and property transactions have fallen by 50 per cent since summer 2014 during the precise period the US Dollar Index rose 20 per cent and oil prices fell 40 per cent. Coincidence? Absolutely not. Merely the macroeconomic logic of the UAE dirham’s currency peg to the US dollar. Fed rate hikes mean mortgage rates in the UAE will begin to the rise at the precise moment 25,000 units are delivered. Since current Brent crude prices are well below the budget breakeven price of almost all GCC states, expect cutbacks in government spending/new projects amid fiscal deficits. Since government spending dominates the economies of all GCC states, falls in non-oil GDP growth rates are inevitable. This is negative for bank credit growth, asset quality, corporate profitability and stock market valuations.

Leave a Reply