Prepare for an “avalanche” of sales dollars?

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Jay Powell’s speech in Jackson Hole all but sealed the September rate cut deal. The markets cheered. The angels were singing. All is well again now that the pivot is finally materializing.

But perhaps the most notable subsequent market move came in currency markets, where the dollar index fell to its lowest level in years on Friday. It recovered some of that this week, but dollar sales are likely to get much worse, according to Eurizon SLJ’s Stephen Jen.

Morgan Stanley’s former currency supremo believes the greenback’s recent slide could turn into an “avalanche” as dollar depositors with a nervous eye on America’s growing trade and budget deficits and “no loyalty” to of the world’s de facto reserve currency begin to flee.

After his last note:

The high cash rate on USD deposits masked the underlying deterioration in the dollar’s quality. The twin deficits have steadily expanded to alarming levels. Even though no FX strategist has mentioned the “twin deficits”, that doesn’t mean they aren’t a huge problem for the dollar. The USD’s high cash rate has also attracted money that is not loyal to the dollar, including the receipts of Chinese exporters over the years.

These huge dollar deposits held by those not loyal to the dollar pose an “avalanche” risk to the dollar as the Fed cuts rates and as the dollar falls: The Fed could cut linearly, but dollar depreciation will likely non-linear.

The Jen has been bearish on the dollar for about a year and a half, during which time it is largely tracked sideways. “Even if I wasn’t right, I wasn’t that wrong either,” says the former Morgan Stanley man. You can take the human out of the sales side, but not the sales side out of the human, etc.

There’s something in the wind, though. The greenback has already suffered its strongest decline since the start of the month last November, according to Barclays, dollar sentiment – ​​a combination of positioning data, options declines and “own work on public sentiment found in the press” – has turned recently. “max short from max long”.

Also, the latest CFTC data suggests that speculators are now long international FX against the USD.

But could fears of the dollar’s demise prove to be overblown? As Société Générale’s Kit Juckes points out, much of the currency’s strength stems from US exceptionalism, or the fact that “for several years, we’ve all been buying dollar-denominated assets.” For the dollar to continue to fall, in other words, the return on capital elsewhere must improve.

There is also a chance that the Fed will ease monetary policy less aggressively than expected, leaving the dollar looking oversold.

Goldman Sachs analysts wrote in a note last week that “it’s difficult to argue against dollar losses a month before the start of a tapering cycle,” but that the bank’s economists still expect labor market data “will be strong enough for the Fed to take more action. gradual way than the price now”.

Structurally, we think Fed tapering is unlikely to materially outperform global benchmarks. Faster Fed tapering is likely to be supported by faster adjustments in other jurisdictions as well, especially as activity data has disappointed: China’s growth target appears unlikely to be met without more policy support, and Eurozone PMIs have offered more signs that restrictive policy is weighing on activity outside of an Olympics-related boost for the French service sector.

Since we also don’t think the Fed will need to use all of its available policy space to ensure a soft landing, this should leave US assets still relatively attractive, even if the short-term rate differential narrows a bit. This has provided the key pillar of support for the high appreciation of the dollar in recent years. And we think the looming US election should hamper portfolio flows amid political uncertainty.

The US non-farm payrolls report out on September 6 is shaping up to be an important one, JPMorgan says, with markets “already bracing for volatility around the release.”