Appeasing the Gods of Debt

The Dollar Is U.S. Government’s Sacrificial Lamb

I have to imagine that after the November the U.S. dollar just had, our buck is feeling a bit like a Thanksgiving turkey: Carved up.

For the month, the greenback fell nearly 4%, the worst monthly performance so far this year.

The culprit: The world.

Investors from Tokyo to Toronto think they have a bead on the Federal Reserve, and their bet these days is that the Fed’s done. No more rate hikes to come.

More likely, they think, rate cuts are coming.

I’m in that camp, too, though for different reasons. From my perspective, this isn’t so much a “We whipped inflation!” as it is a “Uh oh! Uncle Sam’s debt costs have exploded higher. We might wanna rethink these meshuga rate-hikes.” But that’s well-trodden ground in numerous past columns, so I’ll move along…

Instead, let’s focus on what currency traders see…

These days, more central banks globally are cutting rates rather than raising them. That puts the Fed increasingly out of step with the world. Now, granted, that’s probably not going to weigh on the minds of Fed rate-hikers, but it does mean that the U.S. would become increasingly non-competitive.

That math: If the Fed keeps U.S. rates high, or even raises rates more, then the dollar’s current weakness will reverse course and shoot higher. Investors would be able pocket easy gains in something called the “carry trade”—selling currencies with low rates, to buy currencies with high rates. Investors capture the spread between the two rates, without a ton of risk.

However, for manufactures and importers overseas, a pricier greenback makes U.S. products less competitive vs. local products. So, U.S. multinationals lose sales abroad. That hits earnings, which hits stock price, which totally freaks out the board of directors, who immediately call a confab with the C-suite jockeys and tell them in no uncertain terms, “Raise the stock price, or else!,” which then results in the C-Suite jockeys telling regional and divisional managers to cut costs, thereby leading to layoffs, which hits family wallets, and slows the U.S. economy.

To be clear, the world of currency traders is betting that scenario isn’t what we’ll see.

They expect rate cuts, and rate cuts mean the opposite of rate hikes in terms of the dollar’s direction.

U.S. interest rates right now are 5.5%, tied with New Zealand.

The British pound sits right below us at 5.25%.

Canada’s hovering around the 5% range. Australia, Sweden, Norway, and the Eurozone are all between 4% and 4.5%.

If the Fed pulls out the carving knife, then U.S. rates start converging on the rest of the world. That carry-trade gap narrows… and, suddenly, there’s more focus on America’s house-of-cards fundamentals than on the chance to collect a minimal premium trading one currency against another.

And in that world, the dollar doesn’t hold up terribly well because of exploding debts, a White House administration that seems wholly unconcerned about its extreme deficit spending, and a political body in Congress that is populated by a troop of slow-learning bonobos. Those are the primary reasons that bond-rating agency Fitch cut America’s debt rating in August, and why competitor Moody’s last month lowered its outlook on Uncle Sam’s debt to “negative” from “stable.”

Now, to be sure, there’s good news in the Fed cutting rates, should the arbiters of the economy choose that path.

Stocks, bonds, and crypto would rejoice with a gangbuster rally.

The housing market would breathe anew as mortgage rates slide lower.

Bank chieftains would feel instant relief from all the pressure they’ve been under because high interest has pinched their lending business and has destroyed the bond portfolios that undergird most bank balance sheets.

All in all, a big W for the U.S.

But a big L for the dollar.

Personally, I don’t mind the dollar taking the loss.

Uncle Sam needs to find a sacrificial goat somewhere to appease the Gods of Debt. Might as well be the dollar, because the government, the consumer, and Corporate America have all suffered mightily over the last 20 months or so because of the impacts high rates have imposed on debt-servicing costs.

If currency traders are right, November’s dollar decline is a sign of happier days ahead.

Well, at least until The Crisis arrives.

But that’s for another time…