The strong US dollar gets stronger

0:06Pushkin. The dollar is motoring higher. It is up something like 6 % in the past 50 days, dragging down all kinds of currencies from the sterling to the euro to the yen. Today on the show, we discuss why the dollar is so strong right now and why it matters for anyone who uses currency to pay for things. This is Unhedged, the markets and finance show from the Financial Times in Pushkin. I'm reporter Ethan Wu coming to you live from the London studio for once, joined in the flesh by FT Markets editor Katie Martin. You exist in real life in human form. I wasn't sure that you did exist, but now I've confirmed for myself.

0:44You know, I trust but verify is kind of my philosophy when it comes to that. He thought I was like an AI Katie Martin. You died 10 years ago and they trained you on all the columns you've ever written. I feel like this is a segue. Welcome to London, Ethan. And the connection between me being in London and this currency show that we are doing right now. So, Katie, I got off the plane at Heathrow. And the first thing I did at the airport is I went to that horrible little currency ATM that charges you ridiculous markup and a service fee. Why, though? Why, though? Because I'm stupid. And I paid$1.30 per pound.

1:24Yeah. And I got like 140 pounds. The exchange rate is 120. One pound will buy you$1.22. Oh, God. And not only did I pay this exorbitant exchange rate, I also found out when I got here that you guys all use cards now, like an actual civilized country. I thought it was going to be the type of thing where I'm paying in cash everywhere. Yeah, we don't pay in like bits of stone. Well, I just, I finished this George Orwell book earlier this year, and there's a bunch of like currency gibberish in there. I did not understand. What is a two bob bit? What is a bob note? What is a half crown? I don't know what any of this stuff is.

2:00Okay, so some of this is the old money, so it's a bit silly. But like, yeah, like a quid is a pound is the main thing that you need to know while you're here. So if someone says to you, right, that's five quid or that's a fiver, that's five pounds. Fiver. Americans, you hear that a quid is one pound and don't do your FX trading at the airport. Anyway, we need to talk about why it matters, right? That the dollar is so strong. One way to understand it is from the perspective of a tourist, right? If you are coming into a country with a strong currency from the country you came from, you just buy more stuff.

2:31Yeah. That's, I think, pretty intuitive. Most people get that. Presumably, you've been like trawling around Harrods while you've been here, like spending money like it's going out of fashion. Yeah. My purchasing power is way up, which I appreciate. Yeah. The things are expensive in London, I will say, even compared to New York. But that's not the only way that a strong currency matters. I mean, you know, one thing that matters a lot for Europe is that Europe imports a lot of energy, especially from the U.S., Middle East, parts of Asia. And oil primarily is priced in dollars. So it has a big impact.

3:03Yeah. So you know what they say about the dollar, right? It's our currency, your problem. Specifically my currency, your problem. Correct. And so all major economies, apart from kind of Japan and China, that's a slightly different issue. But most major economies are really struggling with high inflation at the moment. And the last thing they need is for all of the oil and other commodities that they import that are denominated in dollars to be getting more expensive. And that's what's happening as a result of having dollar strength at the moment. So on the margins, it's not helpful to inflation profiles in places like the UK and the Eurozone.

3:39We're not at extreme levels where policymakers are going to start standing up at G7 meetings and saying, we really need to do something about this. Also, there's nothing you can do about it unless the Fed changes its mind and starts cutting rates. But on the margins, this is not helpful for inflation in a series of different major economies. Yeah. And there's also the context that the country in at least sort of in the West with the most benign inflation profile is the U.S., which is now the country that via the currency is creating inflation problems elsewhere and disinflationary pressures at home through the stronger dollar.

4:11You know, it's given the Europeans and the Brits an inflation problem at a time where, you know, it's not like inflation is completely out of control. It seems to have come down a bit in the U.K., but it's not like you guys you guys could use the help right now of a weaker dollar. really. Yeah, it would be helpful. It just goes back to the big theme that's running through markets at the moment is American exceptionalism. So there's this idea that in most major economies, interest rates have risen to the point where they're at the peak or close to the peak, and they're going to stay there for quite a while.

4:38And what the market is saying through things like bond yields and through the dollar is that we think this is going to be a more painful process for other countries than it is for the US. We think the US can withstand this, whereas we think big economies like the eurozone and the uk have got a serious growth problem coming down the line and they are more likely to blink when the you know when the recession hits than than the fed is so i i think this discussion of american exceptionalism gets us from you know why it matters that the dollar is strong to maybe some of the drivers behind it and i you know the the core currency concept that you're getting to is this idea of the dollar smile and this is the idea that there are like three broad scenarios with the dollar and everything else, and two of them push the dollar up.

5:24Those are the tips of the smile, the kind of edges of your mouth. And the middle part, the down part where the dollar is weaker, is sort of in the middle. So taking it one by one, the dollar is strong in the two scenarios where either the US is crushing everyone else in terms of growth. They're doing way better than everyone else. They're the number one economy, American exceptionalism. That's one side of your smile. The other side of your smile is everything is going to shit. Everything is getting crushed. 2008 type of situation where there's a proper crisis, then people want the dollar for safety reasons.

5:56So those are the two kind of ends of your smile. They both push the dollar up. American exceptionalism and everything getting crushed. The dip in your smile, the middle of the smile when the dollar is weakest is when the U.S. is just kind of unremarkable and things are all right. It's that mushy middle where there's nothing particularly attractive for the dollar in terms of safety or attractive for the U.S. in terms of growth prospects. And we're definitely on the U.S. exceptionalism, like you said, the U.S. exceptionalism end of the smile right now. Yeah. So I was reading a report just before we started this recording from Bank of America, and they were saying that the strength of the dollar that we've seen recently exceeds the fundamentals.

6:36So if you kind of map what the dollar index does, dollar index kind of measures the dollar strength against a bunch of different currencies. If you measure what the dollar index has done against gaps in interest rates between different major economies, against stocks, energy prices, yada, yada, it's still exceeding that. So the dollar is doing even better than you would expect from the gap in interest rates or expected interest rates that we've got. And what we've got now is that the dollar index has formed, drumroll, a golden cross. Now, I'm no fan of technical analysis, as you are probably aware.

7:11I think it's like horoscopes for men, but like on markets where you think, OK, this chart has done this funny pattern. That means that the following things are going to happen. But a golden cross is the opposite of a death cross. And it's one of my favorites. It means that the short term ascent of the dollar has broken through the pace of the longer term ascent of the dollar. So that kind of indicates that it's breaking higher. This could start to become a problem. You know, already we have, you know, there are some signs of unease over yen weakness in Japan. You get some signs of unease over renminbi weakness in China.

7:46Eurozone in the UK haven't said anything on this point yet. We're not at any sort of extremes. If you bear in mind, this week, last year, the pound was in total free fall after the incident that we don't wish to talk about anymore. Liz Truss's great plan to transfer purchasing power from Brits to Americans. Thank you, Liz Truss. That works super well. But, you know, nonetheless, you know, the pace of gains has been pretty handy recently. And all of a sudden, particularly on UK, you're getting this little chorus of notes from the sell side, right? Notes from the banks saying we think it's time to sell sterling harder than we were before.

8:21So Goldman Sachs, HSBC, various others all saying we've got lower targets for sterling than what we had before. So this thing is not over. Yeah. To sort of bolster Bank of America's point. This is from a note that Capital Economics put out earlier this week. Their analysts make the argument that let's remember that U.S. inflation is really trending down and higher for longer may be more of a posture than a reality, that the Fed needs to commit to higher for longer because they can't appear to be weak. But the second that inflation looks like it's coming under control, higher for longer is going to go the way of the dodo bird.

8:59I don't know how much stock I put in that. I'm a little, I think, skeptical of that. But it's worth considering that today markets believe in higher for longer. Tomorrow, who knows? That conviction has been flimsy in the last year or so. It's been on and off. So the bet right now is that even if you do get a bit of economic weakness from the US early next year, the Fed will stick its fingers in its ears and say, la la la, can't hear you. We are not cutting rates into this mini crisis because we've got to fully defeat the inflation monster first. We have to see the whites of Jay Powell's eyes at the time to see whether that holds.

9:36Do you think if you stare into Jay Powell's eyes long enough, you'll see like a golden cross? I've never tried it, Ethan. Give it a go. We should ask our Fed reporter. Yeah. All right, Katie, we'll leave it there, and we'll be back in a minute with Long Short. Welcome back. This is Long Short, that part of the show where we go long a thing we love and short a thing we hate. Katie, I'm feeling long London since I've been here. I mean, maybe I'm just very easily impressed, but, you know, this is the first time I've ever said something positive about the UK on the podcast. It's a really beautiful, charming, world-class city.

10:12It's, you know, people here are like so much friendlier than New York. Really? That's funny. Yeah. No, like if you go to the grocery store in New York, you're expected to scowl at the cashier and the cashier will scowl back at you. That's just that's the way it is. You get beaten up if you do that. If you smile at them, they beat you up here. You know, you go get a coffee or something and there's that kind of British cheer that people meet you with. Plus, it's dead cheap for you. This is true. This is true. My coffee cost me like one quid, 70 pence. Is that? Where? That's a really good price. Ah, it's a coffee shop near, actually it was near here.

10:47Pence? Is that right? 70 pence? Yes. Okay. Like Mike Pence, but money. One quid, 70 pence for a small filter coffee. I'm feeling long London. Okay. I'm going to be really annoying and also be long something. Oh, again. Okay. I'm sorry, but it is what it is. I am long Jamie Dimon rates trader. So the chief exec of JP Morgan, you know, he's supposed to leave this whole like rate strategy thing to his rate strategists. But he is saying we think that the world should prepare for Fed rates of 7 percent. And it's like, lol, it's never going to get high, you know, never going to get that high. bear in mind in January last year, 2022, Jamie Dimon was saying, I think we're going to get six or seven rate rises this year.

11:38How everyone laughed. Everyone thought he was completely wrong. Turns out, if anything, he was underestimating how many rate rises we were going to get from the Fed last year. So if he's saying, listen, I think it's plausible that we get to 7 % on Fed rates, then I'm minded to take him seriously. Yeah. And I guess the implicit short in that entire conversation is smaller stocks and smaller companies that have more floating rate debt. Like how much of the US economy can cope with 7 % interest rates? You know what I mean? Tune in next time to find out, listeners. This time next year, we'll know.

12:11If Jamie Dimon is right, there will be many, much fodder for the Unhedged podcast. Yeah. That's the flip side of it. Yeah. All right, Katie, it's good to be here. It's good to be doing it in this beautiful studio. And listeners, we'll see you back on Thursday for another London-based episode of Unhedged. Catch you then.

12:32Unhedged is produced by Jake Harper and edited by Brian Erstat. Our executive producer is Jacob Goldstein. We had additional help from Topher Forres. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, and Jess Trulia. FT Premium subscribers can get the Unhedged newsletter for free. A 90-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Ethan Wu. Thanks for listening.