The Inflection Point of Dollar's Long-Term Weakening Is Gradually Emerging

Peterson

Bond

Political

Economic

Summary:

On October 4, Kevin McCarthy, US House Speaker and the No.2 person in the US who actually has real power, was removed by voting. It was he who abandoned the principle, gave up the previous idea of deep cuts in fiscal spending, compromised with the Biden administration, and extended the time of the government shutdown, which led to the rebellion of his party. Perhaps McCarthy is already heralding an inflection point that is coming sooner.

Behind the Bull Market

Actually, it may be known to all that US Treasury yields and the dollar once deeply corrected at the beginning of the year, mainly due to the recession expectation under high interest rates. However, the current economic data is resilient, mainly thanks to the contribution of private sectors and the US massive debt issuance as it raised the debt ceiling. As the Fed, the largest buyer, is also stretched, it is natural that more residents and overseas investors are needed to buy US bonds. Therefore, in the case of tightening dollar liquidity, US Treasury yields have to soar. In January, the US government reached its $31.4 trillion debt ceiling. Since the debt ceiling was lifted in early June, the US Treasury has issued $1.7 trillion in bonds in just four months, a little short of the $2 trillion target. Therefore, the tightening of dollar liquidity during this period can be imagined, and it is natural for US Treasury yields to surge and the dollar to rise. Also, this allowed us to witness the 11 consecutive weekly winning streaks of the US dollar. Perhaps, the continuation of policy tightening to fight inflation was just an official pretense. The genuine reason behind it was this tireless issuance of bonds to pay off old ones.

The Situation Has Changed

As mentioned at the beginning, McCarthy, the US House Speaker, was removed by voting, which was the first speaker of the US having been removed. In fact, many US residents have realized clearly that unlimited super fiscal stimulus was unsustainable, and there were many objections to overdraft. The proposition of McCarthy, when he took office, was to urge the government to cut spending. However, he has compromised now and has been opposed and abandoned by the Republican Party. It was a chronic pain to compromise continuously. In the first 11 months of fiscal 2023, the fiscal deficit reached $1.5 trillion, an increase of 61% YoY, which was mainly because of the decline in fiscal revenue caused by falling taxes, while spending was still expanding. In this way, the problem will show sooner or later. Issuing new bonds to pay off the old ones will accumulate more debts. The US bonds are estimated to be the first big problem, and liquidity tightening may evolve into liquidity exhaustion. Once the liquidity crisis breaks out, it will weigh on the Fed. At that point, the Fed may have to cut interest rates and expand its balance sheet to clean up the mess, or it will not be able to avoid a financial crisis. But even if the Fed takes action, it can only delay the arrival of the financial tsunami, but in the end, it is still inevitable. As the foundation of the dangerous building has sunk, even if the debt tower is no longer built, it is only a matter of time before it falls!

What Will Be the Choice of the Market

At the moment, will the United States repeat the policies of the Reagan administration in the mid-80s, which cut the fiscal deficit and loosen the currency? We must know that the United States now has $33.1 trillion in debt. Compared with then, the losses of the US government now required a sharper interest rate cut and greater monetary policy easing. Currently, inflation is basically at a controllable level, which may be the best way out for the United States. After McCarthy's removal, perhaps the road to tightening will not be easy. If deficit reduction and easing policies are achieved, the dollar will show a long downward pattern. Since the early 1985, the dollar depreciated by nearly 50% over two years. It wasn't until 1995 that the dollar lifted. This round may be even longer until a new round of the US economic cycle comes. While the yen and the yuan will be two of the most comfortable assets. Chinese assets may be able to regain the favor of capital, and it is only a matter of time before the gold price hits the previous high!

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