Brief thread on the implications of the U.S. fiscal impasse and the dollar.

Markets are probably underestimating the scale of the fiscal tightening taking place in the U.S.

Since the expiration of the Fed $600 UI benefit, Fed UI outlays have dropped by $17bn PER WEEK. 1/

This is chunky. On an annual basis, this represents a fiscal tightening of ~4% of GDP. Obviously that a misleading figure, but it gives you a sense of scale.

This doesn't even include the growth impact from expiration of PPP and tightening from S&L govts to come. 2/

Can a recovery in the labor market offset the loss of Fed UI?

V unlikely short run. In June, which saw largest in payrolls ever, earnings growth from payrolls amounted to just ~$4.7 billion/week.

Compare this to peak Covid where gov't UI payments were ~$25bn per week. 3/

Can the large pool of U.S. household savings offset the loss of Fed UI?

It will help to smooth the transition, but I doubt its sufficient to offset the income shock. Cont UR claims are running at ~13m/wk, well above GFC highs. The loss of income to this cohort is material. 4/

So in short, the impact from the loss of the Fed UI benefit will outweigh any organic income growth or household savings in the short run. The numbers simply aren't comparable.

This is tragic and really shouldn't be downplayed. It will be a major headwind to the US recovery. 5/

Will these fiscal headwinds weigh on the dollar? Not necessarily. On its own, fiscal tightening is not a necessary precondition for USD depreciation.

2011 marked the start of a major U.S. fiscal consolidation. It also coincided with the start of the 8 year USD bull market. 6/

Will history repeat itself? I don't think so. 2011 was marked by the European crisis and (a bit later) the start of a material deleveraging campaign by China.

In short, it was a combination of cheap USD valuation and a re-rating lower of RoW growth ignited the USD bull mkt 7/

Starting conditions are far different this time. (Yes, I'm saying this time is different).

The USD is close to cycle highs, China's business cycle is showing few signs of slowdown, and leading indicators for global trade still have good momentum 8/

Tighter US fiscal and favorable global backdrop suggests that the latest rally in the USD is probably one you should sell than buy imo.

This could change if, for instance tmrws PMIs show loss in momentum. For now, I think risks to the USD are still skewed to the downside. End