Speaking at Société Générale’s Global Strategy Presentation event on Wednesday, the founder of Global Macro Investor pointed to the roughly $10tn dollars in US dollar debt outside the United States as a key driver in what would be the currency’s third major bull market since it free floated in the 1970s.
The first bull market, he said, was between 1980 and 1987, during which the dollar appreciated almost 100%. The second occurred between 1994 and 2003 and saw the dollar 48% stronger by its end.
So far, from its beginning in 2014, Pal said, the dollar has only increased by around 30%. So, were it to stop now it would be the smallest dollar bull market in history. And, on the weight of probabilities, especially given the current state of the world, is highly unlikely he said.
The first factor at play is the level of US dollar borrowing that has taken place since the global financial crisis.
As the Bank of International Settlements highlighted in 2015, dollar credit to non-banks outside of the US hit $9.8tn at the end of Q2 2015, boosted not only by the growth in emerging markets but also the substitution for local currency credit “given favourable dollar interest rates and exchange rate expectations as EME firms leveraged up.”
Since then that figure has moderated slightly, but with interest rates now starting to go up in the US, there is a growing need for dollars to fund this debt, Pal explained.
“There is a shortage of dollars, which is a strange thing to say given how much quantitative easing there has been, but it is there.
“Foreign dollar borrowing is enormous… People have borrowed money to invest in things they probably shouldn’t have invested in, but did so because the dollar was moving sideways. This sort of carry trade is fantastic, until it is not,” he added.
But, as these positions are closed out, it will mean that the dollar will be pushed higher, especially as corporate hedging practices become entrenched.
The other factor supporting Pal’s thesis is the ‘Trump effect’.
While it is impossible to know exactly which of Trump’s policies will be fully enacted, and although he does not think globalisation has heard its death knell, Pal said the one thing that is clear is that US president-elect, Donald Trump stands for protectionism.
“If you create a world where us goods are less in demand abroad and foreign goods are less in demand in the US you will create fewer dollars in the financial system and, if there are less dollars in the financial system, ie foreigners not selling you so many goods, it will push up the price of the dollar.