SUMMER´S PAUSE IS ENDING / MACLEOD FINANCE

Summer’s pause is ending

Foreign holders of $39.6 trillion have lost 13% on their dollars since January according to the TWI. It more than wipes out any gains made on underlying assets.

ALASDAIR MACLEOD

The chart of the dollar’s trade weighted index is dismal, to say the least.

It is not helped by the president calling for a weaker dollar and putting pressure on the Fed to reduce interest rates. 

But the yield on the 10-year treasury note points to higher, not lower yields.

It’s not quite a golden cross yet pointing to higher yields because the yield is just under the moving averages, which are both rising. 

A convincing rise above 4.4% is all that’s required.

An understanding of credit tells you that when there is greater risk associated with dollars the risk premium rises relative to alternative currencies. 

Foreigners exposed to dollars having sold their own their own currencies to buy them are making precisely this assessment.

You should forget optimist talk of the Fed cutting interest rates and that US bond yields will decline. 

For foreigners the mathematics of risk are what counts, and the value of the dollar relative to their currencies is what matters. 

President Trump, his tariffs, his borrowing plans, and his pure capriciousness together inform foreigners, increasingly concerned about their exposure to dollars and dollar-denominated investments.

This is confusing for US investors who have rarely seen foreigners collectively turn their backs on dollars. 

They simply associate a weakening dollar with falling bond yields, which is normally correct. 

This time is different: the reason why treasury yields can rise and the dollar fall reflects foreign selling in the face of increasing currency risk. 

This was notably the case following 2 April, reflected in the chart below of the 10-year treasury note yield and the dollar’s TWI.

Before 2 April, the treasury yield and TWI correlated as you would expect. 

But when Trump presented tables showing his global tariff proposals — he called it Liberation Day – the correlation was broken. 

Either foreigners were selling, or markets began to discount the probability that they would. 

Since the immediate sell off, Trump backed off from his original tariff threats in the face of market reactions and the correlation has returned, albeit with a value gap.

Tariffs are going to return to the agenda when Trump’s pause on tariffs ends on 8 July. 

Whatever the outcomes for individual nations, it is difficult to see Trump backing down entirely. 

It is likely to mark the commencement of trade wars, particularly between the US and the EU and China. 

It is equally likely to mark significantly higher bond yields as dollar liquidation of dollars and bonds begins in earnest.

That the dollar is over-owned by foreigners remains a huge problem. 

US trade tariffs are disrupting international trade and supply chains. 

The global economy is taking a hit to growth, affecting the US economy negatively as well. 

The consequence is that the US’s debt-cum-credit bubble is in grave danger of imploding, not least because of foreign dollar liquidation.

What happened in the week following Liberation Day looks like happening again — this time without a clear signal ahead of 8 July, being more of a gathering run on the dollar and US treasuries.

Equities are in peril as well

The valuation spread between the long bond and equities is stretched to all-time record levels, and a further move up in bond yields risks crashing equities. 

According to the US Treasury, foreigners own over $14 trillion’s worth of equities, and it will take very little to burst their balloon.

For equity investors who are ignorant of this bond to equity value relationship, the next chart should serve as a wake-up call.

It is not surprising that after its record run gold, which is real money in everyone’s common law, is consolidating close to its all-time highs.

There’s little doubt that gold reflects the weakness in the dollar’s TWI. 

Very few investors appear to realise that it is not so much gold rising as the dollar falling, which is why central banks are selling dollars to buy gold. 

Investors have yet to follow these well informed insiders, owning less than 0.5% of gold and related investments. 

And their loss in value for the other 99.5%+ held in dollars and other fiat currencies over the last 25 years is shown below:

Measured in gold, which is without counterparty risk, a year-2000 dollar is now worth only 8.4 cents, a decline which is visibly accelerating.