Many investors appear to have lost their bearings. It is as if the proverbial rug has been pulled from beneath their feet. Last week’s bolt from the blue by the Swiss National Bank is simply the latest in a string of significant surprises.
The decline in US Treasury yields despite the fastest growth in more than a decade in the April-September 2014 period took many by surprise. The collapse in oil prices was unexpected, even though the increase is US output was widely known. It was also well known that OPEC itself was producing in excess of its quota agreement. In late October 2014, the Bank of Japan took the market by surprise. It decided by a 5-4 majority to dramatically increase its already aggressive easing.Â
Although tomorrow’s likely decision by the ECB has been well telegraphed and anticipated by investors, there are so many moving parts. It is not unreasonable to expect a volatile reaction regardless of the particulars.
As difficult as it may be, medium and long-term investors may be best served by staying focused on the big picture. This key element of this big picture is the divergence between the US and the rest of the high income countries. Specifically, the policy responses to the shock of the financial crisis differed depending on numerous institutional, ideological and idiosyncratic considerations. The different policy responses have produced different economic outcomes. Those different economic outcomes are the critical fundamental fact that underpins our expectation for the dollar to continue to appreciate on a trend basis.
The economic and policy divergence will likely last not months or quarters, but at least a couple of years. This implies, as we have argued before, that the dollar bull market is still in its early days. We expect the euro to fall through parity ($1.00) next year. We suspect before it is over the euro will approach the historic lows set in the 2000-2002 below $0.9000.Â
