«The U.S.&nbsp;dollar is overvalued against almost all the major currencies.»<br>Foto:&nbsp;Victor J. Blue / Bloomberg

«The U.S. dollar is overvalued against almost all the major currencies.»
Foto: Victor J. Blue / Bloomberg

Das Interview

«We are About to Enter a Dollar-Bearish Cycle»

Marc Chandler, Managing Partner and Chief Market Strategist at Bannockburn Global Forex, thinks the reign of the strong U.S. dollar is coming to an end. He anticipates an economic slowdown in the U.S., and explains why 2020 will be a stock picker’s year.

Christoph Gisiger

Deutsche Version

King Dollar has dominated the financial markets in recent years. But now, the writing is on the wall for the world’s reserve currency to depreciate.

Marc Chandler

Marc Chandler has been covering the global capital markets for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 2018. Chandler holds master's degrees from Northern Illinois University and the University of Pittsburgh in American History and International Political Economy. Currently, he teaches at New York University Center for Global Affairs, where he is an associate professor.  A prolific writer and speaker, he appears regularly in the press and writes the popular Marc to Market blog. In February 2017, Chandler's second book was published with the title «Political Economy of Tomorrow» and takes an insightful look on the concept of surplus.
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“The dollar is overvalued against almost all the major currencies. The next big move will be lower,” says Marc Chandler in an extended interview with The Market/NZZ.

The internationally renowned expert on foreign exchange markets bases his bearish forecast on the assumption that the Federal Reserve could cut interest rates several times this year in order to fight a slowdown of the U.S. economy.

In fact, the Chief Market Strategist at Bannockburn Global Forex would not be surprised to see the dollar fall to 1.35 against the Euro. According to his view, the Swiss franc should appreciate against the Greenback as well.

After last year’s strong rally, Mr. Chandler cautions that U.S. stocks are overvalued. He spots better opportunities for investors in emerging markets like Mexico, and he explains why he likes beaten down industrial stocks like 3M.

Mr. Chandler, the financial markets are in an upbeat mood. What’s the outlook for 2020 from a foreign exchange point of view?
Macroeconomics will be on the forefront for a while. The US-China trade conflict and then US-Iran confrontation distracted investors from the macroeconomic drivers of the capital markets. It is not that there is really much closure with the exogenous issues, but they are in a less challenging place, at least on the surface. Also, monetary policy among the large Central Banks in the United States, Europe and Japan seems to be on hold after easing last year. However, we did see the People’s Bank of China easing policy at the beginning of the month and my sense is that there is a scope for further easing. So with monetary policy generally on hold, I’m somewhat negative on the U.S. dollar this year. That said, market positioning among speculators and asset managers still seems to be favorable for the dollar.

Why are you bearish on the dollar?
There have been three major dollar rallies: The Reagan dollar rally, the Clinton dollar rally and the most recent rally since 2009/10 which started in the financial crisis and its aftermath. I anticipated the most recent bull market in my first book titled “Making Sense of the Dollar”. Yet, since about the middle of last year, we’re seeing signs that the forces that made me look for the dollar to strengthen are waning.

What are these forces?
There are three drivers. The first one is the policy mix. The best policy mix for a country’s currency is tighter monetary policy combined with looser fiscal policy. That’s what happened in the U.S. In 2017 and 2018, we had the tax cuts, the spending increases and the Federal Reserve raising interest rates. But now, the policy mix is not as supportive for the dollar as it was in the recent past. The Fed cut rates three times last year and the market is pricing in an 80% chance of another cut this year as the U.S. economy is slowing. Moreover, fiscal policy has turned from stimulative to a bit of a drag, partly because the fiscal stimulus ended, and partly because of the tax increases associated with the tariffs.

What’s the second force?
When it comes to interest rates, there’s a linear way of thinking: higher interest rates should support a currency. Sometimes they do, but I find that there’s more of a cyclical relationship: The last stage of a big dollar rally often coincides with interest rate differentials actually moving against the U.S. That’s the case since the fall of 2018, when interest rates on 2-year government debt started to move against the U.S. compared to Germany, the U.K. and Japan. In the case of German Bunds for example, the interest differential is down about 100 basis points since the peak in early November of 2018. So I can’t predict the exact day the dollar turns, but this pattern tells me that we are in the last stage of the dollar rally.

And what’s the third driver?
This is where President Trump has it right: The dollar is overvalued against almost all the major currencies. As an investor and trader, I ask myself how far can prices move away from value. In foreign exchange, the value of a currency is the purchasing power parity. So how far can that rubber band between value and price stretch? For OECD countries, a currency rarely goes beyond 25% in one way or the other. Today, the Euro is about 23% undervalued to the dollar, and the British pound is almost 20% undervalued. The concurrence of these three factors tells me that the next big move in the dollar will be lower.

At what levels will the Greenback trade at the end of 2020?
Against the Euro, I have the dollar a little bit weaker at 1.15/1.16. As a matter of fact, a 1% or 2% shift in a currency is no big deal. So I’m talking a little more than that because, thinking ahead, the market is going to try to position itself for 2021.

And what’s your outlook for the Swiss franc?
The weakness of the Euro keeps the Swiss National Bank from being able to normalize monetary policy to a meaningful degree. At just above 1.07, the Euro is basically trading at a multi-year low against the Swiss franc. When we have some more bad geopolitical news or other things like that, it’s entirely possible that we’re going down towards 1.06. So the pressure stays on the SNB to try to keep resisting the strength of the franc. Against the dollar, it’s a different story, because I have the weaker dollar as the overriding factor. But the exchange rate to the dollar could go down to 0.95 or even a bit lower which is really a key area, technically speaking.

What about the medium to long-term perspective?
We are about to enter a dollar-bearish cycle, and the cycles in the currency markets can last many years. Also, these moves can get a life of their own. Back in 2008, the Euro peaked at about 1.60 against the dollar. It’s hard to say that we will go back to those extreme levels. But something like 1.25 or 1.35 is plausible. One of the perennial concerns dollar bears always allege is the U.S. twin deficits: the budget deficit and the current account deficit. At different times in the past, foreign appetite to finance the twin deficits has waned. Today, we’re already seeing that some countries like China or Russia are trying to diversify away from the dollar. So I can imagine a scenario where President Trump gets reelected, economic nationalism goes forward, and the U.S. needs higher yields to attract foreign investors to finance the deficit.

Then again, the European economy doesn’t look particularly healthy, especially compared to the U.S.
In Europe, we’re getting some mixed signals. For example, German factory orders in December fell sharply, but industrial production went up. The Eurozone economy has reached some stability, but it hasn’t recovered really well yet. So we need to see better news, and we might not get them until later this year, I’m thinking Q2, or maybe Q3. For now, what we’re seeing are different problems in different countries: Large demonstrations - once again - against President Macron’s reform plans in France. In Germany, it seems that the service sector is relatively strong. But the manufacturing sector is still weak. And then of course, you have the perennial problems like Italian politics and the European banking system. Yet, Europe has its soft patch already, and China is trying to come out of it whereas the U.S. is just going into it. That divergence is going to work against the dollar.

Why do you think the U.S. economy is going to slow down during the course of the year?
America is experiencing the longest expansion in history. This expansion has not been very strong, but very long. That means it’s very vulnerable. So I look for the economy to turn down - maybe not a recession, but just slower growth. In my view, that’s already happening. There are two main indicators that help us locate where we are in the big cycle, and they peak typically in the middle of the cycle. The first indicator is the non-farm payroll number. In 2019, the U.S. has created about 175,000 jobs a month on average compared to around 225,000 in 2018. So when we look at job growth, the economy is already slowing down.

What’s the second main indicator?
Auto sales. Besides a home, the auto is the largest thing people buy. Like non-farm payrolls, auto sales are also gradually slowing down. The twelve-month moving average peaked a couple of years ago. So I’m not predicting that there is going to be a big turn. I just think the economy will gradually slow down.

How will the Federal Reserve respond to that?
For Federal Reserve, the trade-off will remain what it was in 2019: Inflation is low, there are risks to the economy, and they can take out cheap insurance policy. However, what’s tricky about this year is the presidential election. The election shortens the time window for the Fed to act, and that’s going to tie the Fed’s hands after September. So the first interest rate cut could take place in Q2, and maybe the other cut in Q3.

The Fed is still injecting a ton of liquidity into the financial system to calm the short-term funding markets. What’s going to happen when the Fed tries to wind down “Not-QE” in the first half of 2020 as Chairman Powell indicated?
It’s like in a car. As a driver, you have two fluids you might put into your car: oil and gasoline. The gasoline is to get the car forward, and the oil is to make sure that the engine works properly. What the Fed is doing with its repo operations and T-Bills purchases is really about putting oil into the transmitting mechanism of the economy. To exit these measures, communication is important. Otherwise it will lead to confusion in the market, and there’s already a lot of confusion since a lot of people say what the Fed’s doing is QE even though the Fed denies that. The Fed said that they’re committed to buy $60 billion of T-Bills a month through “sometime in Q2”. I suspect that “sometime” might go through at least April, since there are tax payments due around the middle of that month. The problem is that T-Bills are short-dated obligations. So what does the Fed do as these obligations mature? They might say they’re committed to replacing them. This means they will not be extending the balance sheet anymore, just replacing the maturing issues.

What does this mean for the bond market?
The long end of the curve is going to be more influenced by inflation and growth, not so much by Fed policy per se. Today, 10-year treasuries are trading at around 1.8%, and that’s not going to change much this year. Maybe it’s going to be a little bit above 2%. But at 2%, you’ll see investors come in and buy U.S. bonds. At the short end, we’re trading at about 1.6% - and that’s basically right on top of the Fed Funds Rate which is at 1.55%. If I’m right, and the Fed cuts rates this year once or twice, 2-year treasury notes could finish the year a little bit above 1%.

The trade war between the US and China played an important role for the Fed to take out some insurance cuts and ease monetary policy. What happens now, after the phase one deal?
What’s important for investors is that the tariff war between the two largest economies is not escalating. And, if China sticks to its agreement, there is some chance that the U.S. will reduce some of the tariffs that are already in place later down the road. But in the big picture, that doesn’t really change the U.S. rivalry with China. Both countries will still look to frustrate each other’s ambitions. That’s why I’m in the camp that the U.S. and China have entered into some kind of Cold War relationship.

During the most intense phase of the trade dispute, the Yuan broke through the closely watched level of 7 to the dollar. What’s next for the Renminbi?
The fact that China is not cited as a currency manipulator in the Treasury's report is supposed to be a significant event. It is not. The markets hardly reacted when the U.S. cited China as a currency manipulator five months ago. Some observers link the yuan's strength, and it is at its highest level since last August, to a quid pro quo: China strengthens its currency, and the U.S. lifts the designation. This assumes Chinese officials gave the label any significance when the IMF itself refuted such claims. By citing a 1988 law instead of the congressional update of 2015, the Trump administration effectively debased the threat and removed the stigma. Ultimately, it was seen as a political rather than an economic judgment. China, successfully snapped the near-magical significance investors and observers had given the CNY 7.0 level.

The stock market was longing for the phase one deal for months. What’s going to happen with U.S. equities in an environment with a weaker dollar?
A strong dollar may hurt earnings, but there’s a lot of tools companies can use to hedge against foreign exchange fluctuations. And, we’ve seen the U.S. stock market go to record highs with the strong dollar. Yet, when I look at the Stoxx 600 index, European stocks have also gone to record highs with a relatively weak Euro. So knowing the currency directions is not enough to know what it means for stocks. Bonds are a different story because at the end of the day, interest rates and foreign exchange rates are two dimensions of the price of money - and their relationship might not be linear, but cyclical.

Where do you see opportunities for investors against this backdrop?
It’s tough because stocks had such a huge bull move. I’m worried that they’re overvalued because we’ve gone up too far too fast. Credit spreads are very tight, too. That’s why I’m concerned that investors are not being rewarded for extra units of risk they’re taking on. It’s worth remembering that sometimes the return of your capital is more important than the return on your capital. The pendulum can swing between fear and greed, and it’s always most embarrassing to lose money because you have been greedy. So if 2019 was about buying the benchmark indices and going for the ride with U.S. stocks and many other equity markets, 2020 may be more of a stock picker’s market rather than an indexing market. Also, since interest rates are so low, I still look for individual companies with a solid dividend yield knowing that it might be difficult to repeat last year’s strong advance.

What names do you like specifically?
Names that didn’t really participate in the recent rally. In the U.S., the manufacturing sector has been beaten up. There, I like the sort of standby classics like Minnesota Mining and Manufacturing, famously known as 3M. For the same reasons I also like the emerging markets.

What does a softer dollar mean for emerging markets?
If the Dollar is weak because the U.S. economy is slowing and the Fed is cutting interest rates, that’s not so good for emerging markets. On the other hand, we’re seeing rising commodity prices. Interestingly, while commodity prices have gone higher, shipping costs have gone down. The Baltic Dry Index for instance, has fallen sharply. That benefits commodity producers.

What are your best investment ideas when it comes to emerging markets?
Last year, the U.S. trade deficit with China had fallen sharply. But the U.S. deficit with almost every other country has gone up. So I look for countries that benefit from shifting production away from China. Vietnam might be played out on this theme, but Mexico is very interesting since it has become the biggest U.S. trading partner. When China joined the WTO back in 2001, there was a large industry movement out of Mexico into China. Now, that the U.S. has put tariffs on Chinese goods, more manufacturers are coming back to Mexico.