Perma-bear Albert Edwards: This is why the US dollar is rallying, and why it may not last

There are four key reasons for the U.S. dollar’s sudden rise, and two of those might not last much longer, Societe Generale’s perma-bear strategist Albert Edwards said in a note on Thursday.

The U.S. dollar has certainly climbed, with the dollar index, which measures the greenback against a basket of currencies, at 92.5050 at 9:01 P.M. SGT on Thursday, after trading at levels under 90 just a couple weeks ago. The dollar/yen has also risen to 109.327 by 9:18 P.M. SGT Thursday, up from levels around 104 in March. And the euro was fetching just US$1.1975, compared with levels above US$1.24 in mid-April.

The suddenness of the U.S. dollar’s rise has puzzled analysts. But Edwards pointed to four reasons for the rise, even if two of them may not last much longer.

The first reason is that interest rate differentials have accelerated in favor of the dollar since the fourth quarter of last year, he said.

That’s a two-pronged move: firstly, the U.S. two-year Treasury note yield has begun an upward move since the final quarter of 2017, he noted.

“One of the key features of this rise has been the explicitly stated resolution of the Fed to stick to its tightening schedule, irrespective of the weakness in equity prices,” Edwards said. “For much of this tightening cycle, the two-year rate has been anchored close to the Fed Funds rate due to the market’s lack of conviction that the Fed would fulfill its tightening promises as represented in its dot chart.”

The second prong was the rise in the U.S. 10-year Treasury yield and signs that the dollar/yen pair has begun to move in line with 10-year bond differentials, he said.

The next reason is “extreme bearish dollar positioning leaving the greenback vulnerable to a reversal in sentiment,” he said. “Extreme speculative positioning is usually seen by market commentators as a contrary indicator.”

And a final reason for the U.S. dollar’s rally is that gross domestic product (GDP) growth surprises in favor of the eurozone have been abating, he said.

“Focusing on actual GDP forecasts underestimates the huge swing in sentiment on growth differentials. For it is likely to be economic surprises relative to expectations that drives the market, and it appears that investors just got too darn overoptimistic about the eurozone recovery,” he said.

Limiting the rally?

But Edwards said that the dollar rally could be limited by CFTC data shows extreme bearish positioning in the U.S. 10-year Treasury, which has been a factor keeping the yield from breaking over the 3 percent level decisively.

“The fast money is already short,” he said.

The 10-year U.S. Treasury yield was trading at 2.94 percent at 9:52 P.M. SGT Thursday.

Additionally, there were some recent signs from the eurozone Citi Economic Surprises Index that the region might see an uptick in surprises, he said.

“If the U.S. 10-year rise in yields abates soon due to the above speculative excesses and the collapse in eurozone economic surprises recovers somewhat, we are left with two dollar bullish factors (instead of four),” he said. “We are left with the widening of the two-year spread and most importantly how quickly (if at all) extreme bearish dollar speculative positioning gets washed out the system.”

Edwards was also concerned that President Trump and U.S. authorities would act as an overhang on the currency.

“I would expect some aggressive verbal intervention quite soon if the current strength continues. No-one wants an excessively strong currency,” he said.