Capital flows are turning against the dollar, says Oxford Economics

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Capital flows have been supportive of the U.S. dollar but this trend might just be ready to turn, challenging already stretched dollar bulls, said Gaurav Saroliya, director of macro strategy at Oxford Economics.

The dollar has been pushed to fundamentally expensive levels, but “the U.S. basic balance — the combined current account, net foreign direct investments and net portfolio flows — is becoming a drag for the U.S. dollar, which, apart from the U.S. growth slowdown and the pricing out of [Federal Reserve] rate hikes, is a powerful dollar-bearish impulse,” Saroliya wrote in a note.

Earnings season is in full swing and U.S. stocks traded higher for it on Friday, with both the Dow Jones Industrial Average














DJIA, +0.84%












 and S&P 500














SPX, +0.97%












 in the green.

But more and more analysts see U.S. economic growth softening in 2019. And with a slowing expansion, the relative attractiveness of U.S. assets looks vulnerable due to weaker expected corporate earnings and an increasingly dovish Fed policy limiting expected dollar returns.

Meanwhile, worries about the so-called twin deficit — the current account and budget deficits — have come back to investors’ minds. The current account includes foreign investment in the U.S.

“While China’s surplus has been diminishing for some time, the surpluses in the eurozone and Japan have also begun falling,” Saroliya said. “The need for the dollar to adjust lower in order to attract inward capital is stressed by these shifts.”

On Friday, the ICE U.S. Dollar Index














DXY, -0.72%












 , which measures the buck against six rivals, was down 0.7% at 95.906.

“Current dollar valuations reflect expectations of a further decline in dollar liquidity as the Fed balance sheet unwind and the declining excess reserves raise concerns about U.S. interbank liquidity shortages,” Saroliya said.

Should the Fed end the normalization of its trillion-dollar balance sheet sooner, “along with stabilizing China growth, will again help capital flows gravitate away from the U.S. and towards higher-yielding and cheaper markets such as emerging markets and pockets of ex-U.S. developed market equities,” he said.

That said, “without clearer signs of growth stabilization in China and other major blocs, investors will probably stick to U.S. assets. But signs are emerging of more Chinese easing and reform measures ahead,” which could soothe such concerns.

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Source : MTV