By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
The Euro traded in a mediocre, narrow range ever since it hit an 18 month low at 1.11 just after the release of the above consensus 3.2% US first-quarter GDP data. Yet the Euro cannot stage a convincing breakout above 1.1280 even when the US dollar is hit with negative news on China trade tensions.
There are macro headwinds that abort a convincing Euro rally. As geopolitical tensions in the Gulf, Libya and Venezuela rise, Brent crude trades above $70 and the Old World faces an oil shock. The financial markets are still nervous about the economic fallout of Brexit, the political succession to German Chancellor Frau Merkel, weak Eurozone survey data, toxic Italian politics and the end of ECB President Mario Draghi’s tenure. The US tariffs against China are a threat to the Teutonic Fatherland’s (Germany is one third the Eurozone GDP) export machine. This means the path of least resistance for the Euro is to move lower, possibly to as low as 1.08. The rise of far-right political parties is in the European Parliament elections is another negative factor for the Euro as are Trump’s auto tariffs threats.
The risk premium in Italian government bond spreads over German Bunds prove that the Italian banking system/fiscal black holes are still a threat to the Euro. These myriad political, economic and positioning factors explain why the Euro has been unable to benefit from the Powell Fed’s monetary policy U-turn (hawk to dove) since January FOMC. The positioning data from the interbank FX market and the Chicago IMM futures pits suggests an epic speculative short has accumulated against the Euro since early April. The net short position against the Euro is the highest since early 2016 when crude had plunged below $30 and China’s bear market had spread global contagion to Wall Street.
I expect the Euro to remain soft even as the US Treasury-German Bund interest rates spreads narrow as the financial markets price in Fed rate cut at the September or October FOMC. I have made no secret about my conviction that a secular bull market for the US dollar began in 2014 amid an oil price crash, a refugee crisis in Europe, the Kremlin’s military intervention in Syria/Crimea and a surge of terrorist attacks from Paris to Nice, Brussels to Bayern. This is my King Dollar thesis. The US Dollar Index (57% is the Euro) has soared 20 points in the last five years, a deflationary big chill for both the EU and the GCC’s greenback pegged economies!
The scale of the King Dollar uptrend is only matched by the (1981 – 85) Regan Superdollar and the second term Clinton Superdollar, boosted by the Silicon Valley tech boom inflows, an Uncle Sam budget surplus and the EU’s diplomatic impotence to end the Bosnia/Kosovo wars of the 1990s. The conclusion is obvious. This is the third epic King Dollar bull market in the post Bretton Woods era of floating exchange rates. There is no real reason to believe that King Dollar will be dethroned in the second half of 2019.
The British pound cannot even trade at 1.30, let alone convincingly rally above it. Sterling has now tanked to a three month low at 1.2730 as the currency markets reprice the risk of a no deal Brexit, now that Corbin has broken off cross-party talks with the Tories.
After all, cable traded at 1.3175 in the Jurassic Era just two weeks ago and there is more than a hint of the classic capitulation – or (drip drip Chinese water torture) here. Sterling’s chronic weakness tells me that the resurrected demons of Brexit still haunt the Gothic halls of power in Westminster and Downing Street. The London bookies give mercurial Old Etonian Boris Johnson 2-1 odds to succeed Theresa May as Prime Minister while solid, reliable Jeremy Hunt is 8-1 at Paddy Power. I cannot see how Prime Minister May can avoid a Tory backbencher revolt at the Brexit vote in House of Commons next month. The prospect of a Nigel Farage rampage in the EU parliamentary elections is not exactly reassuring for sterling’s battered bulls.
The risk that Theresa May’s government collapses amid a no deal Brexit is no longer unthinkable, a scenario that slams sterling below 1.20. 2019, like 2016, will be Britain’s summer of discontent – jolly boating weather, duckies!