After a pretty strong rally this year, the US dollar has pulled back slightly from its mid-August highs, helping to release some of the pressure on gold, commodities, and emerging markets. Back in June, Felix Zulauf warned on our show that if the dollar rally continues, this represents a “deterioration of global liquidity” and is “bearish virtually all asset classes” aside from high quality bonds.
Here’s what he had to say on our program (see Big Picture: Felix Zulauf on Trade Wars, Market Outlook, Gold, and More).
The dollar will remain strong on a major trend basis probably into next year because of the divergence we see in the policy mix, Zulauf told listeners.
We have an expansive fiscal policy in the U.S. against a backdrop of neutral fiscal policy overseas, he said. With tightening monetary policy in the U.S. relative to other major countries, the dollar should hold up well, and since we spoke with Zulauf, the dollar has indeed strengthened.
The dollar is an important barometer of the world economy, he added, with a weak dollar usually signaling world economic expansion and acceleration. This happens because the credit system by itself creates more dollars in a feedback loop with economic expansion.
If the dollar is stronger, this signals a slowdown because the global economy isn’t creating as many dollars, given that it is the global reserve currency.
“This is a deterioration of global liquidity,” Zulauf said, and is “bearish in virtually all asset classes except prime quality bonds. If you’re looking into prime quality bonds, you have the U.S. Treasuries and you have German bunds.”
While Zulauf doesn’t find German bunds attractive here, he does see value in U.S. Treasuries, which he thinks will likely see falling yields into year-end.
He’s also not too concerned about the growing deficit in the U.S. or rising inflation rates, because forces outside the U.S. are dampening those factors.
If currencies outside of the U.S. decline further, we will have input prices for the U.S. going down, not up. With emerging market difficulties, the CPI dampened, and with commodity prices and foreign currencies both falling, the dollar should remain attractive.
From a macro point of view, this setup is not bullish for global equities, but he expects investors to be able to hide in U.S. bonds for some time. The strongest market will be that of the U.S. because the capital flow will lend support to our economy.
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