Currency futures contracts imply “a meteoric rise of the U.S. economy while the eurozone and the rest of the world crash and burn,” but the reality may be that the U.S. and the eurozone are not so different and the market herd is mindlessly stampeding toward a cliff.
That is the sobering warning that Merk Funds founder Axel Merk delivers in his latest commentary on the dollar and other currencies, specifying that stocks, bonds and the dollar are all vulnerable as momentum investors cram into the same bandwagon.
“Asset bubbles tend to be popped after too many people have piled into the same trade,” Merk writes.
The mutual fund and ETF exec’s main focus is the long-term rally of the U.S. dollar, whose currency counterpart has been the euro that investors have generally been eager to sell.
Yet, Merk asks, how different are the U.S. and European economies in actuality?
Presenting a chart of forward inflation expectations, one can see that the U.S. has tended to be 50 basis points higher — currently a little north of 2% in five years, while the eurozone is a little above 1.5% in five years. But the two economies’ courses have closely paralleled each other.
Despite the similarity, the U.S. and the eurozone are routinely seen as economic antipodes.
“As the Fed was contemplating an ‘exit,’ the ECB was contemplating QE…The glass was perceived to be half full in the U.S., while half empty in the eurozone,” Merk writes.
And yet at the points where inflation expectations approached the Federal Reserve’s 2% target during the years since the global financial crisis, the Fed would always announce another round of QE while offering assurances that economic recovery was under way.
“In fact, for those that haven’t noticed, the U.S. has not raised rates as of yet,” Merk mordantly notes. “But we have been told over and over again that the U.S. is on its way [to] raising rates.”
So, with two major economies that are weak and policy divergences that are less dramatic in reality than in perception, Merk is suggesting that the market may be exaggerating U.S. virtues and European faults.