When the British voted to leave the European Union the pound collapsed, but cable’s crash did not result in across the board US dollar strength. After an initial rally, the US dollar spent the second half of the summer drifting back to levels approximately equal to where it was trading before BREXIT.
But over the past month as the Fed has affirmed its decision to raise rates at the upcoming December meeting, the US dollar has once again resumed its rally.
I had assumed this was a healthy rally. Bonds were selling off and the US dollar rallying because the US economy was picking up. Yet I am beginning to worry about that conclusion. Have a look at this chart of the US dollar versus the Citibank Economic Surprise Index:
Economic releases have suddenly started coming in below expectations. Maybe the US dollar strength is not as healthy as I hoped.
What is happening? Why the sudden divergence between the US dollar and the economy?
For that answer I look for clues from one of the most under appreciated strategists going - Nordea’s Martin Enlund. If you don’t follow Martin you are definitely missing some of the best charts and ideas out there.
Martin highlights how periods of Chinese Yuan weakness have preceded risk sell offs.
Here is a chart of CNH versus the S&P 500.
I can’t remember who said it, but someone remarked how each time the Federal Reserve has tightened, or even hinted at hawkishness, the Chinese have put the screws to the CNH. The Chinese do not want the Federal Reserve to tighten monetary policy and there is a bit of a subtle battle occurring in the financial arena. The Fed tries to tighten, the Chinese sell assets and then the Fed chickens out of tightening.
I worry this recent US dollar rally might accelerate and cause the Chinese to react even more violently.
When Yellen recently shifted towards her “lower for longer” stance I was hopeful that a “one and done” rate rise would be tolerated. Yet the recent action is causing me to second guess this conclusion. The global financial system might not be strong enough to handle even the Fed’s single rate rise.
For short term traders the US dollar is the key for risk assets. If the rally continues the chances of an accident in the stock market increase dramatically. For longer term traders it might make sense to take a wait and see approach before committing any more money.
I hate to be so mopey with my call. I am not turning all-in bearish like most pundits, but I am acknowledging that this US dollar action is quite concerning. And if I was to be bearish on any index, it would definitely be the US stock market. Too many investors are hiding in the US assuming the “best of breed” will save them. I will look to buy emerging markets on any sizable dip, and I am still hopeful that a big sell off in the Euro currency will make my Eurostoxx index outperform on a nominal basis. I am short Euros and the Canadian dollar, and instead of betting on a declining stock market, I might just add to those positions.
Speaking of the Canadian dollar, the bad news just keeps coming. A couple of days ago Bank of Canada Governor Poloz said they were actually quite close to cutting interest rates. From the Financial Post:
This dovish move makes sense. The Bank of Canada has been loathe to cut rates in the past few quarters due to a fear of stoking the housing bubble. Given the government’s new rules tightening credit to the real estate sector, the Bank of Canada has the green light to ease monetary conditions for the rest of the economy.
And it looks like the Canadian economy will need it. Today Canadian retail sales were announced and they came in at a disappointing -0.1%. Last month was also revised from -0.1% to -0.2%. Inflation also came in lower at 1.3% versus an expected 1.4%.
That’s bad news, especially when you combine it with the following great chart from Nautilus Research:
Crude oil is entering a traditional bearish seasonal period, yet speculators are almost as long as they have ever been:
The Canadian dollar is pushing up against a clearly defined trend line. I don’t think it can take much more bad news before exploding out of the range.
Thanks for reading and have a great weekend,