To the moon, Alice! – Jackie Gleason, The Honeymooners

In our New Year’s Day Year In Review post, we doubted the market’s conventional wisdom the dollar would weaken throughout the coming year.  Not emphatically,  but we doubted,

The dollar index was up over 4 percent on the year hitting a high of 97.71 in mid-December.  Markets are betting on a lower dollar.  Not so sure.  We will watch and wait and don’t believe the U.S. is heading into a recession in 2019 – GMM,  Jan 1st

The following chart explains the recent dollar strength, in our opinion, with the Dixie now trading with a 97 handle and only 0.6 percent away from its Dec 14th high at 97.711.

Source:  Renaissance Macro

Exchange Rate Determination

We have written many pieces on what determines exchange rates.  Here is a synopsis from a post last October,

We cut our teeth as a young economist on Anne Krueger‘s book,  Exchange Rate Determination.   The book is dated, but we highly recommend it, a good and quick read.

FX traders use many models to justify and fundamentally rationalize trades at any period in time, such as:

1. GDP growth differentials;
2. Interest rate differentials;
3. FX reserve levels (mainly in the emerging markets, especially);
4. Current account balances;
5. Capital flows;
6. Purchasing Power Parity (long-term model);
7. Other;
8. and, now, Greg’s PMI Differentials

FX traders are married to none of the above, and switch back-and-forth between the various FX models, or, at least, they act as if they do.  – GMM, Oct 2nd

Traders have definitely zeroed in on recent growth and interest rate differentials and are whipping and driving their short-term positions accordingly.

We see no let-up unless the U.S. economy rolls over unexpectedly.  Doubt it.

Much of the weakness in Europe is due to Germany and its trade-dependent economy.  It’s possible with a China trade deal and Trump easing up could improve expectations.  And pigs do fly.

We perceive the post-War order, i.e., globalization, is crumbling and markets are in complete denial or just plain ignorant.  That is the major factor why we believe even long-term investors should be wary of the risk markets until assets get much cheaper.   We believe they will.

Upshot

The dollar goes higher.  Breaks through 97.711 high (only 0.6 percent from current levels) with a measured move to 101.722, or a move of 4.8 percent.   The emerging market trade is over.  Taking profits and moving on.

As always, we reserve the right to be wrong.   Stay tuned.