The Inevitable Defeat of the Deflationist

Supreme USD strength has, on the face of it given the deflationists (weakening US economy) the confidence to claim a decisive victory over their reflationary opponents (growing US economy).

The deflationist argument (and it sounds wholly plausible) is that a stronger USD will make US exports more expensive and that could cut into the profits of many US companies, which could harm or stop any recovery.

While a strengthening dollar was not a big issue when US exports were a small part of corporate earnings, now more than 40% of profits for The S&P500 come from overseas.

Their argument is further strengthened when we witness price action and deflation at work in all commodities as well as government debt which in some cases yield less than 0%.

This MACRO piece will try and outline why from a historical fundamental viewpoint this may not in fact be the case.

At the top of the last reflationary high in the middle part of 2011 the USD as measured by the USD Index was trading at its low. It found its base at that level and spent the next two years jockeying with the Euro for leadership.

That all changed towards the end of 2014/beginning of 2015 when the Euro fell intensely out of favour and the USD intensely into favour.

The reasons cited for this are many and include amongst others: differentials in interest rates, economic data, future policy expectations from the various main central banks, rate hike expectations in the US; no rate hike expectations in Japan and fresh interest rate easing in both China and Europe.

All have given impetus to the USD resulting in the USD Index trading at its highest point since 2003.

A very short history lesson.

If we compare the price action of both the USD and the Euro since the middle of last year with that of the middle of 2008 we find many similarities. In both instances the deflationists won as commodities fell, yields collapsed, inflation expectations collapsed and doom and gloom prevailed.

But and it is a big but the main point of difference between 2008 and the present is that the investment climate then was one of extreme caution with ‘risk-off’ being the order of the day. Presently the exact opposite presides with extreme optimism and ‘risk-on’ being the only order of the day.

This sentiment has meant that the huge demand for USD’s needed to buy USD denominated assets has resulted in all other currencies being sold in order to buy it. The USD is in other words is being carried and held aloft by the huge shorts in other currencies.

 A slightly longer short history lesson.

Those readers who were trading the markets in the 1990’s will remember how the strong USD led all USD denominated assets higher. The currency that was most shorted at that time and carried the USD aloft was the Yen. The same argument was used by the deflationists then as it is now.

The subsequent result was not however very pretty for those Yen shorts as the following graph beautifully illustrates.


Yes the USD is mightily strong and yes the deflationists continue to gloatingly pound their chests as commodities collapse, yields collapse and whilst the reflationists run for cover in disarray a very, very hugely unexpected and therefore devastating change in fortunes is imminent. It is so imminent we can virtually smell it.

The following graph tells you all you need to know about which asset class we are most fond of currently.


The deflationary camp will realise soon enough that the pleasure of winning a battle or indeed a string of battles pales into nothingness when they lose the war.

DISCLAIMER: The information contained in this publication is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Users acknowledge and agree to the fact that, by its very nature, any investment in CFDs and similar and assimilated products is characterized by a certain degree of uncertainty and that, consequently, any investment of this nature involves risks for which the user is solely responsible and liable. Any recommendation, opinion or advice contained in such material reflects the views of TFF, and TFF expressly disclaims any responsibility for any decisions or for the suitability of any security or transaction based on it. Specifically, any decisions you may make to buy, sell or hold a security based on such research will be entirely your own and not in any way deemed to be endorsed or influenced by or attributed to TFF. Past performance should not be seen as an indication of future performance. Market and exchange rate movements may cause the value of your investment to rise or fall and an investor may not get back the amount invested. Investors considering opening a self-trading account or investing in the TFF Capital Pool, should limit their exposure to maximum 10% of their investment capital. Eligibility for participation in the capital pool is subject to final determination and acceptance by TFF. Investments are not obligations of, deposits in, insured or guaranteed by TFF.
About the Author
TFF aims to provide our customers with the best skills and knowledge to achieve their personal financial goals and level the playing field. The senior officials and staff of the TFF Team have more than 80 years experience in financial product trading, sales and fund management. For more information on TFF CLICK HERE.

Related Posts

Leave a Reply