Why the US dollar is the world’s problem

0:06Pushkin. The US economy really seems to be getting something right. I mean, we've had some slightly dodgy numbers recently, but the gap between where the US is and where the rest of the world is seems to be getting wider. Today on the show, we want to know what is the US secret sauce? And more importantly, what does this mean for investors and markets and for the rest of the world? This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here in London, and I'm joined, finally, after a little break, by Rob Armstrong, who writes the Unhedged newsletter in New York.

0:45Rob, how are you doing? I'm doing well. I'm just back from Switzerland, where I met a lot of very important banker types. And I'm sure you were sparkling company for the very important banker types. But what I want to know is, what is your main contribution to the US economy? Well, my son eats so much at this point, He's 14. That I think he's actually having a noticeable effect on U.S. food prices. Yeah. Yeah. I own one of these specimens as well. They can really pack it away. They will screw up your refrigerator. It's bad news. So listen, tell me, why are we talking about the U.S. economic miracle when, just a few days ago, we had some actually quite sort of stinky first quarter GDP numbers from the U.S.?

1:34Yes. The headline was deceptive. So everybody was looking for 2.4 % growth in the first quarter. That's quite fast growth. Yeah. We got 1.6. And that's annualized. We should remind our listeners because you do it differently in the States from how we do it. So that's 1.6 % growth rate for the year. Which would be a round trend growth rate for the U.S. economy. But the U.S. economy has been growing faster than that. Yeah. It was like 3.4, was it, in the previous quarter? So that would be a huge slowdown. That would have the growth going away. However, that headline was really deceptive. There's all these weird puts and takes in GDP numbers for things like inventories and the trade deficit and whatever.

2:17And if you look through those rather technical factors, the underlying picture of the U.S. economy continues to be one of remarkable strength. So if you look at personal consumption expenditures, they are chugging along at about a 6 % annualized rate still. Is this the mighty U.S. consumer striking again? We do not bet against our propensity to shop. It's not just the mighty U.S. consumer. Investment in the U.S. is positive. Housing investment, corporate capex is strong. wrong the manufacturing sector which was kind of the loser or the class dunce of the U.S. economy during COVID it's taken off its dunce cap and seems to be growing again so looking through the headline we see a U.S.

3:09economy that continues to outperform. Is it really valid to like say okay here's the number but if you take out this and you put in that and you take out this and you put in that, that it's actually better than expected. Surely you should just look at the number and trust the number. Yes. But as always with accounting, there is some smoothing. There will be volatile numbers that will kind of correct over the course of a whole year. So I think there's some validity with an individual quarter saying this is stronger than it looks because this little bit went down in the first quarter that we know for mechanical reasons is going to go up in the second quarter.

3:45But I agree with you. The road of adjusting headline numbers is the road to hell and perdition in general. Yes. It leads to adjusted EBITDA, right? Where financial truth goes to die. Yeah. It leads to being one of those guys on the internet. Can you take it a stage further, though? Can you argue that actually the US economy is overheating Because what the knock-on effect of all this is, is that inflation just is not going away in the way that we hoped. Is not. If you look at a chart, as I am right now, of the Fed's preferred measure of inflation, which is PCE inflation. I'm not even going to go into what that acronym stands for.

4:32It's just going the wrong direction. Month by month by month. The trend is wrong. It's not even flat. It's not gone honey badger. It's not like shooting, like rattling higher, is it? But it's just not going the right way. It's supposed to be going down. The story, you know, three months ago, the clear story of the economy was inflation's on its way down. The Fed will cut rates and everyone gets a pony. And that story is dead. There was a moment where we thought we were going to have six rate cuts this year. Now the market is down to two and the market might still be wrong. It may be less than two, judging by how the numbers are going right now.

5:12Yeah. Are we even two? Are we like, it might even be like one and a bit now, right? Because like all the notes that I get from like the sell side, that's banks to you and me, they're all like ripping up their June, July cut forecasts. And they're not saying, okay, we'll take a punt on September instead. They're saying, let's call it December. Now, normally, normally when a big sensible bank staffed by like intelligent economists moves something as important as a US rate forecast, then these things tend to go a month, two months, maybe three months at a time. You don't normally see the street say, right, we're pushing this whole thing out by six months.

5:50This is like a massive shift, isn't it? Well, I think this reflects a lesson we've all learned the hard way in the pandemic, Katie, which is when strange things happen, like a pandemic or a demand shock or whatever, a massive demand push, the numbers become very hard to predict. And economies can change very quickly. And so we have this intuitive idea that economies have a certain momentum, right? That today's number suggests that tomorrow's number is going to be similar. Yes. Things keep going the way they have been going. Yep. Things are not keeping going the way they have been going lately.

6:28And that's a good lesson for us. When we project the current state of the U.S. economy out, we should do so right now with low confidence. Yes, definitely. But we know where we are now. Where we are now is high growth, high inflation, probably high rates for longer. And that's where we're at. It's an unambiguous story for now. But where this becomes like quite a big deal for markets and macro is that the rest of the world is not in the same boat. So central banks never promise what they're going to do next. But for example, the European Central Bank has made it pretty clear that its firm intention is to cut rates in June.

7:08Like barring disaster, it's going to do it really soon. It's going to start cutting rates now. Yeah. It is super weird and unusual to have the ECB moving out of step with the Fed. And what does that mean? Is this a quiz? Is this going to contribute to my final grade, Katie? Yes. Yes. Well, we have a rate differential. How about that? How's that an answer? So the rates are going to be high in the US and low in Europe and something's going to happen. So we get this gap. And then one of the kind of knock on effects of that, of course, is all things being equal, you get a weaker euro, you get a stronger dollar and a weaker euro.

7:47Why do we care? Why do we care about that? Why are we talking about this? Well, one important thing is a lot of stuff in the world is priced in dollars. Most paradigmatically a lot of food and all of oil is priced in the dollar. So if you are sitting there in Madrid with your euros,$80 oil, even if the price in dollars didn't go up, is now more expensive for you. Or buying American soybeans, they're suddenly more expensive for you. So to the degree you're an importing country, you are going to have higher costs on your hands all of a sudden. It crimps your style. Yeah. And the inflation that all the kind of monetary authorities have been going out of their way to try and defeat has just like this extra bit of support.

8:38I mean, it's worth bearing in mind, it's not just a uniformly bad thing to have a weak currency against the dollar, right? So if you're sitting there and you're making Mercedes cars, say, Right. Yeah. Now the Americans are buying them at what feels like the same price to an American, but is a much higher price to you in euros. So if you're an exporter country, maybe you like this. But then again, that's a bit inflationary for you, too. You know, that stokes your economy. I did see that Germany had some decent GDP numbers this morning. So maybe that's part of the story there. Yeah, but you also get these kind of pockets of stress, don't you?

9:17So like, for example, just the other day, we had what certainly looks and smells, but has not been totally confirmed as an official intervention to strengthen the yen, Japanese yen, because the dollar has just been monstering the yen for like months and months. And it got to like really quite ridiculous levels around 160 yen per dollar. And all of a sudden it hit an air pocket and the yen sort of rattled higher. And so it looked like the central bank is out there spending its reserve dollars to buy yen and support the yen. My theory about this is they're just trying to get all the damn tourists out of the country.

9:53It's become so cheap to visit Japan that the place is basically crawling with Americans and Europeans. And they can't stand anything. I hear it's wonderfully cheap and a fantastic place to visit. I'm literally thinking about going there myself. Yeah, yeah. But to make the point seriously, Japan is a classic example of a country that imports a great deal of food and all of its energy, basically. All of that is priced in dollars. And this stuff starts to pinch, even though they're an exporter. They sell plenty of stuff. On balance, a very strong dollar relative to the yen causes them pain and uncertainty that they cannot bear to the point where the central bank appears to have intervened the other day.

10:33So this stuff is a big deal. This stuff is a big deal. And we've already had, so Indonesia raised rates to try and support the rupee because the dollar was ripping into it there. We've had Korea expressing some unease over the exchange rate there. So, you know, at this point, we are not at the level where the dollar is getting disorderly or that it's just rocketing higher against absolutely everything. Particularly for emerging markets. Yeah, yeah. A very strong dollar is one component. When things get messy in emerging markets, often a very strong dollar is one of the culprits. It's because when the returns on super safe, reliable old U.S.

11:16treasuries and similar assets are very good, investors come in on the risk curve and are less likely to grab at extra yield in emerging economies. And so that means money starts to pick up and leave Latin America, Africa, emerging Asia and move back to the United States. And those countries are very dependent on capital flows. So that could be a pain point that we would be looking for in months to come if the current trend of the dollar continues in that direction. And if they're paying back dollar debt, then that suddenly becomes more and more expensive over time. So I don't think we're kind of anywhere close to panic stations yet.

11:59But I don't know. I wouldn't mind betting that if we're having this conversation again in six months time, then various authorities in Europe and around the world would be saying, yeah, you know what, Uncle Sam, this is getting like really quite annoying. This is making our life difficult. Let me throw a theory at you about how the U.S. economy could slow down and inflation could fall. If you remember all those pandemic excess savings, none of us Americans went out to eat because we were locked in the house and the government sent us these great checks and we had all this extra money. while it is hard to measure exactly how much of that extra money is left, the amount looks to have recently hit something like zero.

12:42Right. And you finally run out of cash. It could be. It could be that the mighty American consumer we referred to earlier in weeks and months to come could cool it a little bit. And if that is the case, we could see some of this problem take care of itself. Could be. Yeah. Yeah. No pressure, American consumers, but we're all counting on you. We're going to leave it there. We're going to be back in a sec with Long Short.

13:19Alrighty, it's time for Long Short, that part of the show where we go long a thing we love, short a thing we hate. It can be anything, anything we like. And so, for that reason, I am Long Pubs. Wow. I know. Rob, I don't know if you're aware, but end times, Brits are apparently avoiding the pub. We were reporting on this the other day. There was some research from Deloitte saying that Brits are spending less in the pub than at any time since COVID. I mean, is nothing sacred? Katie, I remember living in the UK, which I did for some years, and constantly hearing this story. The great British pub is they're going out of business, like four pubs close every week.

14:02And I remember looking around the streets of London and estimating that there were two pubs per capita in your country. So I think any reports of the death of the British pub are to be greeted with some skepticism. Yes. Another potential support for pubs comes about because my dear eldest child is turning 18, which is the drinking age over here, very soon. Well, in England, you have quaint pubs. In America, we have McDonald's. Sure. And I am long McDonald's. They reported earnings just recently. Results were a little bit disappointing. But as I mentioned earlier, my life is one long, restless search for enough food to keep my son's stomach full.

14:52And we stop at McDonald's all the time. I'm not ashamed to admit I like the food. I think the company is really well run. I think it's a good product at a fair price. It's no pub. But I'm Long McDonald's. I am. OK, well, you go to McDonald's and get yourself whatever it is you're going to get. And we'll be back in a couple of days in your feed. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler.

15:31FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.