Weak dollar will weigh on U.S. equities. Heavy consequences for holders of American assets

It is impossible for Trump to “nationalize” the foreign exchange market as he has done with financial markets. The dollar will therefore pay for the crisis and make holders of American assets pay dearly for it.

By Maurizio Novelli, manager of the Lemanik Global Strategy fund

It is fairly evident to market professionals that the credibility of the U.S. financial system is now at historic lows and is likely to worsen alongside the increasingly obvious difficulties facing the economy and the policies meant to support it. Further confirmation of this situation is the plan to eliminate the FED’s independence from government influence. Indeed, the pressure on Powell shows that unsustainable fiscal policies need interest rates to be controlled directly by those who keep issuing debt without limit. In any case, Japan’s experience confirms the scenario now unfolding for the U.S. economy; the BOJ also gave up its independence in connection with the crisis of the Japanese Shadow Banking system in the 1990s.

The truth in all this is that you can push passive management to invest without looking at fundamentals, you can nationalize stock markets and impose yield curve control (YCC), you can “politicize” macro data to hide a recession, but you cannot nationalize the foreign exchange market, because it is global. The dollar therefore remains the asset that will pay for the crisis and will make holders of American financial assets, both in the equity and bond markets, pay heavily for it.

And Europe? Europe has a colossal historic opportunity that it may fail to seize. The rearmament plan risks becoming the classic choice of buying time instead of making the structural reforms that are needed. Looking closely at the expected fiscal push from such a project, it is clear that it risks ending up like the EU fiscal stimulus plans that preceded it (Next Generation EU, PNRR, etc.). All European fiscal stimulus plans have faded away along the way — why? Quite simply: stimulus plans lasting 10 years and spread over periods that are too long lose effectiveness after an average of two years. Typically, the impact of fiscal stimulus is always short term and has its most significant effect in the initial phase; if you then spread it over excessively long time horizons, the fiscal multiplier fades on average after 12/18 months.

The real EU reform would be the creation of a single capital market and the issuance of Eurobonds. If all member countries today had a debt-to-GDP ratio of 60%, as required by the Maastricht criteria, what would prevent converting part of that debt stock into Eurobonds? If we were to decide today to convert part of the public debt of individual states into Eurobonds, we would immediately see the following positive effects: 1) creation of a sovereign bond market competing with U.S. Treasuries; 2) attraction of foreign capital to finance European infrastructure projects; 3) state budgets relieved from having to raise domestic resources to finance European projects through local public debt; 4) the fiscal policies of individual states would focus more on domestic projects, while EU projects would be financed with EU debt; 5) easing of the debt trap affecting some European states (France, Italy, Greece, Portugal); 6) recovery of fiscal flexibility for the most indebted countries.

The current EU financing mechanism, which runs exclusively through individual state budgets, requires ever more expansionary fiscal policies at European level while at the same time imposing restrictive fiscal policies on individual countries that must finance the expansion of the EU budget. What is emerging on the horizon, then, is a potential conflict between national fiscal policies and those managed by the European Commission, which tend to become increasingly important relative to national ones in the management of fiscal policies across the entire euro area.

It is now clear that no European country, except Germany, is able to implement fiscal policies adequate to overcome economic stagnation. If EU fiscal policies become the real driver of European growth and the scale of such measures is set to increase, it is inconceivable to continue thinking that they can be financed by debt issued by each individual state, which must nonetheless comply with restrictive fiscal parameters. The real “game changer” is therefore not the rearmament plan but the implementation of the Draghi plan, whose key pillar is the creation of a capital market that can compete with the dollar. I am not particularly optimistic about the EU’s determination to move quickly in this direction; however, a possible crisis could accelerate that path.

Clearly, this also does not bode well for the dollar in the long term, and I do not think it will be welcomed by American policymakers, who may do whatever they can to obstruct it. In any case, this is another reason why I see the risk of American decline as increasingly likely, while China has not yet tapped the potential of its domestic consumption and Europe has not yet launched the reforms needed to make “the leap” and become one of the drivers of global growth. At present, the area that seems best placed to emerge from this situation is certainly China and EM (Asia), while Europe has not yet clearly defined whether it wants to move toward greater integration. What is evident is that the current capitalization of U.S. markets, built on capital inflows from abroad, is the real systemic risk that no one is truly pricing in.

Therefore, the dollar is likely to fall to 1.40 against the euro and to 120 against the yen within 12, at most 18 months, causing carry trades to break down and triggering a broad risk off move in U.S. financial assets. Gold will continue its current upward trend, and a target of 3,700/3,800 over the next 6/9 months is now in sight. The target I had indicated at 3,500 by year-end has almost been reached, but in the meantime the situation has deteriorated further. U.S. equity markets, despite the nationalization, will not be able to withstand the outflow of foreign capital and will suffer the impact of the weakening dollar.

At present, 30% of American financial assets are held by foreign investors, the highest percentage ever recorded statistically since the 1920s, and higher than the level reached in 2000 (25%), before the bursting of the Nasdaq bubble. If you want to defend these assets, you must print as much money as is leaving the system, thereby intensifying the currency crisis and, as a consequence, the financial one. Our portfolio allocation — long Gold, short dollar and short Equity — is aimed at providing protection in the event of a financial crisis triggered by the current unmanageable imbalances and structural criticalities, which make the current American economic model unsustainable and increasingly vulnerable to an inevitable crisis.