Despite pandemic turmoil, the US will suffer a smaller economic contraction than the eurozone this year (-5.3pc vs -8.1pc on market forecasts). It will emerge less damaged because it is a closed economy, somewhat shielded from the collapse in trade volumes, and because it is better able to mobilise a fiscal bazooka of sufficient scale. I have little doubt that a second jumbo package will be agreed on Capitol Hill before recess.
America’s flexible labour markets will smooth the switch from dying sectors to the post-Covid champions more easily than Europe’s rigid job protection regime.
It is possible to sketch a scenario where the Fed winds down monetary stimulus and perhaps even sounds hawkish by next year, which would set off a blistering dollar rally, ceteris paribus. But does anybody in their right mind think that the European Central Bank could contemplate lifting interest rates or tightening policy this side of the mid-2020s?
The ECB went through an entire cycle of global expansion without managing to extract Euroland from a “lowflation” trap. It ended up semi-paralysed with rates at the rock-bottom floor of -0.5pc.
Europe has since been hit with the biggest economic shock since the Second World War, pushing Italy’s sovereign debt ratio to 160pc of GDP. The ECB is a permanent prisoner of negative rates. Any hint that it planned to step back from the bond markets would set off a run on Italian debt.
Athanasios Vamvakidis from Bank of America says the “short dollar” trade is based on faith in a “V-shaped” recovery for the rest of the world that is not actually happening, and on the false conclusion that Europe has met its Hamilton Moment and embraced debt mutualisation.
“We are concerned the consensus is too optimistic on the global economy; too optimistic on a vaccine; too pessimistic on the Covid-19 situation in the US compared with that in Europe. We disagree with the view that the EU Recovery Fund sets a precedent; the consensus is focused too much on the deterioration of the US debt and is complacent about similar trends in the rest of the world,” he said.
“We do not know when and which G10 central bank will start tightening monetary policy first after the pandemic, but we certainly would not expect the ECB to do so before the Fed. The ECB balance sheet could expand well beyond that of the Fed,” he added.
Ultra-dovish monetary policy usually leads to currency weakness so why have speculators and fund managers pushed up the euro so exuberantly over the last four months, lifting the ECB’s trade-weighted index to a six-year high?
Morgan Stanley says the dollar is “the most oversold in 40 years” and leveraged funds are running a record net short position of $50bn. It is a mood music trade, based on impressionistic chatter that Europe has got its act together. There is talk of a blow-off spike in the euro to $1.30, lifting sterling to nearly $1.40 along with it.
A forensic study by Bank of America’s Evelyn Herrmann and Ruben Segura-Cayuela should destroy any illusion that the EU’s €750bn Recovery Fund does what it says on the tin – especially since a Covid resurgence risks wrecking what’s left of the Club Med tourist season.