A Stronger Economy Will Continue To Fuel The Dollar

Over the past two days, we’ve looked back at a couple of the six market themes I expected to dominate in 2016. Back in January, I said “central banks are in control, be long stocks.” That was theme number one. And I thought “China’s currency manipulation would come home to roost.” That was theme number six. Both have clearly materialized. As for China, its currency manipulation has become center stage with the incoming President Trump.

Among the six themes we discussed back in January, I also expected the dollar to continue on a big run. I said…

“The dollar is in a long term bull cycle—Be Long Dollars

When we look back at the long term cycles of the dollar over the past 40 years, we see five distinct cycles for the dollar. And these cycles have lasted, on average, about seven years. The most recent cycle is a bull cycle, started in March 2008, yet has underperformed the average of the past six cycles. While the bull cycle appears to be long–in–the–tooth, in terms of duration, the fundamentals for dollar strength have just recently swung massively in favor of the dollar. We have an historic divergence in the monetary policy path of the U.S. relative to Europe and Japan—a very rare occurrence to have the Fed going one direction (toward raising rates) and two major economic powers going the opposite direction, aggressively.

This huge monetary policy divergence dynamic creates the potential for a sharp extension in the dollar over the coming months.”

The dollar has indeed been strong, but only after a correction earlier in the year. In the past week, the dollar index has reached a 14–year high.

With the Fed projecting three hikes next year and Europe and Japan still going the opposite direction (full bore QE), the dollar trend doesn’t look like it will slow anytime soon. And despite what many are warning about what a stronger dollar might do to growth, a strong dollar tends to accompany strong growth historically (and it doesn’t kill it). On the other hand, it should be fuel for the rest of the world, as cheaper foreign currencies give the weaker global economies a chance to export their way out of an economic rut.

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