Currency Volatility Tracker

Fund Manager Issues Warning on U.S. Dollar

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Yahoo Finance photo
Peter Schiff, shown above, says that the Fed's policies have gone from "misguided" to "irresponsible" to dangerous."

Peter Schiff warns that the U.S. dollar could be in for a sharp fall as soon as currency traders realize that the Fed may not raise interest rates anytime soon.  "Like a horse with a bit in its mouth."

"Everybody is speculating," said fund manager Peter Schiff, the CEO of EuroPacific Capital in an eye-opening interview on Yahoo Finance on Thursday.  "The conventional narrative is that the Fed is going to be raising rates and the rest of the world is going to be easing," said Schiff.  "It's based on that that speculators have bid up the dollar."

Indeed, the dollar has been on a tear against the world's currencies rising 27% against the euro in the past year (see accompanying chart), 19% against the Japanese yen and 11% against the pound.  Overall, the dollar has risen 5.3% this year as measured against a basket of currencies, according to the WSJ Dollar Index.

Schiff says the rising dollar in the face of a growing current account deficit proves the dollar is over-valued.  "Look, we got the current account deficit that came out today, it jumped by 14%, the biggest increase in two years," according to Schiff.  "This would normally be negative for a currency, and, of course, that current account deficit would be even higher if the Fed raised rates because we would have to pay more interest to our overseas creditors." 

The current account is a net measure of transactions between the United States and the rest of the world in goods, services, investments and transfers.  A deficit in the current account means that the supply of dollars exceeds the demand, which would lower its value.  The U.S. current account deficit increased to $113.5 billion in the fourth quarter 2014 from the $98.9 billion in the fourth quarter of 2013, the Department of Commerce announced on Thursday.

Schiff says that currency traders are ignoring the fundamentals and going long on the dollar.  "The fundamentals are weak but the fundamentals don't matter right now when you've got this false narrative and the traders are running with it like a horse with a bit in its mouth," said Schiff.  "It's a reflexive action right now to buy the dollar on the dip."

But, Schiff warns that this irrational, speculative trading won't last forever.  "But when traders wake up to reality and realize how wrong these bets are they are going to unwind these trades and the dollar is going to implode very quickly and I think the people who have been betting on the dollar and have been making a lot of paper profits will end up losing a lot of money."

Investors and traders did wake up briefly last Thursday after the Fed's policy statement made clear that officials aren't set on a short-term interest rate increase in June, as many had assumed.  Soon after the Fed's press conference the dollar plunged 2.5% against the euro leaving traders in a liquidity panic. 

"It was a like a zoo," said Masafumi Takada, director of currency trading at BNP Paribas in New York.  "Phones were ringing.  Traders were struggling to fill orders.  Sales tradres were screaming and yelling for the fill," according to an article in the Wall Street Journal on Friday, March 20th. 

Schiff presented the possible worst-case scenario.  "When people realize we can never raise rates and its permanent QE and the Fed can never strengthen its balance sheet and it has no ability to control inflation, ultimately it has to let it run rampant then there is no place to hide," said Schiff.

"You've got even the soundest central banks around the world deliberately creating inflation with negative interest rates promising to debase their currency.  In fact, the new mantra is that price stability is bad, we need rising consumer prices," Schiff said of the central banks.  "It's like firemen coming to your house to set fires, not put them out."