I gotback from the MoneyWeek cruise yesterday.
I had a great couple of nights. It's the second cruise we've done, and again we had a fascinating group of readers join us.
There was lots of stimulating conversation. We covered plenty of topics, ranging from the existential threat posed by pollution, to the prospects for property investment; from debating the ultimate point of building wealth, to the simple pleasures of a Friday night chicken kebab.
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It really made me think hard about what's going on in markets
And I keep coming back to the US dollar...
The strength of the US dollar is incredibly important
The Fed fumbled the ball on US interest rates. It was far more cautious than everyone had expected at September's meeting, and that briefly rattled markets. But they've quickly recovered their composure.
If US interest rates aren't going to rise as quickly as everyone had thought, then there's less reason to favour the dollar over other currencies. And a weaker dollar tends to mean higher commodity prices and less pressure on emerging markets (and China, for that matter).
Is this a sustainable rebound? I'm guessing that this primarily depends on what happens to the dollar and US rate expectations in the weeks and months to come.
The argument goes that the US Federal Reserve doesn't (or shouldn't) pay attention to external events. It's America's central bank, after all. But that's simply not true and never has been.
I was re-reading hedge fund boss Ray Dalio's thesis on the way the economic machine' works on the plane back from Athens yesterday. He notes that in the 1930s 1931 to be precise the strong dollar became a problem.
Here's a contemporary quote in Time magazine from the president of Chase National Bank: "The most serious of the adverse factors affecting business is the inability to obtain dollars" There were calls to reduce or cancel debts that allied countries owed the US, basically to free them up to spend more money on American exports.
And before this, the then-Fed chair had "privately advised" President Hoover to "cut war debts by 70% and reparations by 40% to improve international trade and financial conditions".
In short, the most important central bank in the world can't and never has ignored external conditions. And no wonder.
A country's currency is a key weapon in its economic armoury. No central bank in the world right now will admit to targeting a specific level of currency, because that would a) have markets focusing on specific currency levels and b) essentially be a naked declaration of trade war.
But I don't think any of you are stupid. It's pretty clear that both Japanese and European monetary policy have been aimed almost explicitly at weakening their overly-strong currencies. And, to an extent, it's worked.
The US is the same. If anything, the US should care more about the dollar. It's the world's reserve currency. In other words, the US has control of the most important currency in the world. It has a massive influence on global liquidity and thus economic activity. That's exorbitant privilege' for you.
A stronger dollar effectively tightens monetary policy across the world. It makes life harder for just about everyone, from US exporters (nearly half of S&P 500 earnings are now made overseas) to emerging markets and commodity producers.
That matters to the Fed, believe me. In effect, the Fed has already tightened and now, despite all the constant proclamations that rates might rise before the end of the year, I think they're warming us up gently for a turn in expectations.
What's coming next and what does it mean?
I've rattled on about this enough in recent weeks already, but I'll say it again because I think it's important. The Fed believes that its greatest sins in the past have involved being too tight with monetary policy. (I'd argue that they lie in taking no responsibility for preventing bubbles in the first place, but I'm not in charge of monetary policy.)
So the Fed believes that if it tightens too soon, it will crash the economy again. It doesn't want to do that. So Janet Yellen would rather be too late.
At the moment, there's no clear evidence of inflation, or huge amounts of strength in the US economy. Overseas, markets are crashing, the S&P 500 doesn't look too healthy either, and finally, the US dollar is strong.
There is nothing in any of this to make Yellen raise rates. She has every excuse to avoid taking that bull by the horns.
So here's what I think: either we won't get any rate rise at all, or the rate rise will come relatively soon but it'll be followed by a statement that explicitly suggests that there won't be another one until the Fed gets a feel for how this one is bedding in.
And I'd argue that it's the dollar that'll make all the difference. I don't know what the Fed's dollar target level is, but I'd warrant that it's lower than where it is today.
What does that mean? We've already seen the mining sector rebound strongly. My concern is that the industry as a whole is so afflicted by over-capacity that life could remain difficult for all but the biggest players there. But one commodity that should be better placed is gold. My colleague Dominic Frisby wrote in MoneyWeek magazine this week about nine gold mining stocks he particularly likes the look of.(If you're not already a subscriber, sign up now.)
