What is your belief about trading price of EUR/USD in the following months? Given the enormous stimulus that the FED induced in the economy respectively to the ECB one, considering the current inflation rate at 5% in US and 2 something % in EU, my immediate conclusions is that we should expect an ulterior devaluation of US dollar. However, in your article you mentioned that this is a relative game and many countries or institutions are doing the same.
Thank you very much, your articles are very interesting and thoughtful.
Hi Matteo, the inflation differentials you refer to are fully priced in front-end inflation swaps in US vs EU. That means they are reflected in real interest rates and hence they should be already reflected in EUR/USD. I believe the Fed hawkish pivot and the crowded positioning in short USD might cause USD to rally a bit further.
Can you please share what is your current view on the EUR/USD? Do you think EUR will continue to strengthen even more as it has recently or weaken through 2023? Thank u
I agree completely--dollar is tied to risk/volatility more than those other macro variables like trade deficit--although there is some link to relative growth and relative equity flow
Agree the "USD is being devalued" arguments are usually pretty shoddy. But i have two big caveats:
1) 30y real yields are currently -20bp. So someone who retires on a fixed income or with a fixed amount of savings and who (wisely) invests in safe assets is expected to gradually lose purchasing power over the course of their remaining years. This doesn't feel quite right.
2) The ratio of wealth:gdp is at a record high. Does anyone actually believe that wealth could actually be converted into goods & services at anything resembling the current price level? I doubt it. Mostly we're hoping the "velocity of wealth" never increases. If it does, we will have some difficult choices to make and the purchasing power of the USD could easily be the victim.
Interesting analysis, but something does not make much sense. The "average" American does not actually exist. Income distribution is heavily skewed and it would be better to show who won and who lost in the last 14y by income brackets. Would love to see such an update. Thanks!
Yes, the distribution is unfortunately becoming pretty skewed. But the overall analysis still holds true, or at least the ''USD has lost 98% purchasing power since 1920s'' is still a myth that somebody ought to debunk :)
Hi Alf, thank you as always. However, I have a critique:
It is not fair to make an assumption based on *averaged wages*. If you look into that wages you can find a disparity where *most* people's salaries didn't increased at the same rate than the *some* people's salaries.
Your analysis of real incomes assumes that inflation is measured accurately. There are many observers that say inflation is under reported. It appears that for sections of society, inflation is indeed higher than the averages. These people would therefore not have experienced real wages growth.
When you say "So, if European governments are trying to push EUR real yields down more aggressively than US is doing, EUR/USD falls. And vice versa.", is it correct? I would think EUR/USD increases and, actually, I think it is what the graph of yield differentials indicates.
In a different note, how do you model EU as an asset? I see that you estimate differences between 10Y USGOV and 10Y EU, but the EU does not issue debt as an entity. Its members do. How are you estimating that in the graph?
If real yields in currency A are headed lower than in currency B, currency A will lose value against currency B ceteris paribus.
The European Union just started issuing a lot of bonds under their SURE and Recovery Fund programs. Otherwise if you don’t want to use the new EU bonds you can calculate GDP weighted yields for European countries.
Lets say I have constructured a portfolio against long term USD devaluation based around hard assets: gold, other commodities, real estate, and even emerging markets.
Now, lets say that I wanted to dedicated a 5% of that portfolio to hedge risk in case the USD devaluation thesis proves wrong over the following years. I am thinking, for example, in buying long term call options on something representing (or benefiting from) USD strenght/appreciation.
What do you reckon would be the ideal hedge asset to buy those calls for?
My first answer on how to hedge something is by default: sell a bit if you think your portfolio is too skewed towards that trade.
If you really want to keep the full size of trades correlating to a weaker USD and negative real rates, the best way to hedge that is to own some USD denominated (not FX hedged) Treasuries if you are not based in the US.
If you are based in the US, you're left with OTM put options in risk assets and maybe VIX. Although your USD cash should increase your purchasing power automatically a bit in that scenario.
If I understand correctly, your thesis is that USD strength would be accompanied with a rally in US bonds. Therefore, some OTM call options on TLT could be a nice hedge against a portfolio heavily positioned on USD weakness.
What is your belief about trading price of EUR/USD in the following months? Given the enormous stimulus that the FED induced in the economy respectively to the ECB one, considering the current inflation rate at 5% in US and 2 something % in EU, my immediate conclusions is that we should expect an ulterior devaluation of US dollar. However, in your article you mentioned that this is a relative game and many countries or institutions are doing the same.
Thank you very much, your articles are very interesting and thoughtful.
Matteo Ticli
Hi Matteo, the inflation differentials you refer to are fully priced in front-end inflation swaps in US vs EU. That means they are reflected in real interest rates and hence they should be already reflected in EUR/USD. I believe the Fed hawkish pivot and the crowded positioning in short USD might cause USD to rally a bit further.
Hi Alfonso
Can you please share what is your current view on the EUR/USD? Do you think EUR will continue to strengthen even more as it has recently or weaken through 2023? Thank u
By measuring USD purchasing power against metals - e.g. gold - aren't we assuming that gold purchasing power - so not price - is constant over time?
Very smart point. Indeed we are assuming so based on history, but that might not hold true for the future.
I agree completely--dollar is tied to risk/volatility more than those other macro variables like trade deficit--although there is some link to relative growth and relative equity flow
Agree the "USD is being devalued" arguments are usually pretty shoddy. But i have two big caveats:
1) 30y real yields are currently -20bp. So someone who retires on a fixed income or with a fixed amount of savings and who (wisely) invests in safe assets is expected to gradually lose purchasing power over the course of their remaining years. This doesn't feel quite right.
2) The ratio of wealth:gdp is at a record high. Does anyone actually believe that wealth could actually be converted into goods & services at anything resembling the current price level? I doubt it. Mostly we're hoping the "velocity of wealth" never increases. If it does, we will have some difficult choices to make and the purchasing power of the USD could easily be the victim.
Hi Mark!
1. I also pointed that out in the article. Today real yields are negative across the board, which is quite a problem for savers and investors.
2. Agree here as well.
Interesting analysis, but something does not make much sense. The "average" American does not actually exist. Income distribution is heavily skewed and it would be better to show who won and who lost in the last 14y by income brackets. Would love to see such an update. Thanks!
Yes, the distribution is unfortunately becoming pretty skewed. But the overall analysis still holds true, or at least the ''USD has lost 98% purchasing power since 1920s'' is still a myth that somebody ought to debunk :)
Sure. My understanding is that the "median" American still is a net loser, but I can't put a number there.
Hi Alf, thank you as always. However, I have a critique:
It is not fair to make an assumption based on *averaged wages*. If you look into that wages you can find a disparity where *most* people's salaries didn't increased at the same rate than the *some* people's salaries.
Kr, Josep.
Your analysis of real incomes assumes that inflation is measured accurately. There are many observers that say inflation is under reported. It appears that for sections of society, inflation is indeed higher than the averages. These people would therefore not have experienced real wages growth.
Hi Mark!
I used median wages and CPI because those are the reliable statistics out there that reflect most accurately what’s happening at a bigger scale.
Hi Alfonso,
When you say "So, if European governments are trying to push EUR real yields down more aggressively than US is doing, EUR/USD falls. And vice versa.", is it correct? I would think EUR/USD increases and, actually, I think it is what the graph of yield differentials indicates.
In a different note, how do you model EU as an asset? I see that you estimate differences between 10Y USGOV and 10Y EU, but the EU does not issue debt as an entity. Its members do. How are you estimating that in the graph?
Thank you very much.
Best regards
Javier
Hi Javier!
If real yields in currency A are headed lower than in currency B, currency A will lose value against currency B ceteris paribus.
The European Union just started issuing a lot of bonds under their SURE and Recovery Fund programs. Otherwise if you don’t want to use the new EU bonds you can calculate GDP weighted yields for European countries.
Hi Alfonso, which currencies do you see outperforming the dollar longer term?
Currencies with:
- Stable politics
- Good demographics and productivity and low levels of private debt
- Little to no exposure to USD debt
- Positive NIIP
Thanks Alfonso
Hello Alfonso!
Lets say I have constructured a portfolio against long term USD devaluation based around hard assets: gold, other commodities, real estate, and even emerging markets.
Now, lets say that I wanted to dedicated a 5% of that portfolio to hedge risk in case the USD devaluation thesis proves wrong over the following years. I am thinking, for example, in buying long term call options on something representing (or benefiting from) USD strenght/appreciation.
What do you reckon would be the ideal hedge asset to buy those calls for?
Thanks!
Hi Hector! Great question.
My first answer on how to hedge something is by default: sell a bit if you think your portfolio is too skewed towards that trade.
If you really want to keep the full size of trades correlating to a weaker USD and negative real rates, the best way to hedge that is to own some USD denominated (not FX hedged) Treasuries if you are not based in the US.
If you are based in the US, you're left with OTM put options in risk assets and maybe VIX. Although your USD cash should increase your purchasing power automatically a bit in that scenario.
Thank you Alfonso!
If I understand correctly, your thesis is that USD strength would be accompanied with a rally in US bonds. Therefore, some OTM call options on TLT could be a nice hedge against a portfolio heavily positioned on USD weakness.
Did I understand that right?
Thank you!
Yep, that might be a good idea.
Thank you so much!