Stock markets are getting ‘rekt’. That’s how we young people say it. The Dow Jones is currently testing the June lows as I am writing this. We could be seeing new lows for 2022 by the end of the day. The S&P 500 and the Nasdaq are not far off.
Regular readers of Market Moment have anticipated this. I have been detailing the technicals and how certain levels needed to break in order to call a reversal. Markets do have a chance to bottom and reverse at their lows, but we will have to watch price action in the coming days. Unfortunately, other charts are telling me that markets are heading lower.
Readers know that I always mention the US 10 year yield.
The 10 year is in an uptrend and just hit 3.8%. A relief rally could see the markets bounce at support in coming days. But keep in mind, the trend is still up for the 10 year.
But there is one chart which is the true wrecking ball. I am speaking about the US Dollar (DXY).
It was almost three years ago when I laid out the dollar macro trade in a post titled, “The Tale of Two Dollars“. The article is old but is still gold. Many of the things I mentioned have happened or are happening. It really is Brent Johnson’s Dollar Milkshake Theory coming true.
Now why is this important? First of all, the dollar being the reserve currency means it will act as the safe haven. Currently, people are debating whether the dollar move is due to a hawkish Fed, or if this really is money running into safety. Why not a bit of both?
The Fed is the most hawkish of the major western central banks. You can put the Bank of Canada behind them in second place. Both of these banks have their rate at 3.25% and expect more rate hikes to come. The Fed made this clear this past week by raising the 2023 median Fed rate up to 4.60%.
When markets are selling off, cash becomes a popular position. When things are going crazy around the world (you know like wars, climate, energy crisis, inflation etc) uncertainty sees wealth run into the safety of the US dollar. I know many may not agree with the dollar being the safe haven, and I am aware of the steps that Russia and China are taking to hit US dollar demand, but that will be a post for another day. Right now the US dollar is the king of the fiats. Or the cleanest laundry in the basket of dirty laundry.
You must pay attention to the dollar here.
As the dollar gets stronger, it will wreak havoc on the world. Think about those emerging market nations with large dollar denominated debt who need to pay back that debt with stronger dollars. Turkey comes to mind, and it will not be a surprise when these nations shift to the Eastern Sphere who are de-dollarizing.
The dollar is known as the petrodollar due to its use in buying energy. The Saudi’s played a huge part in this when a deal was made between Kissinger and King Faisal. Foreign demand for US dollars has remained high due to this. Now, things are looking a bit shaky with Saudi Arabia. Prince Mohammed Bin Salman (MBS) has been seen in the past getting cozy with President Putin. Recently, OPEC+ changed their mind in helping out lower US prices. The Biden administration convinced the Saudi’s to increase oil production to lower prices. The Saudi’s said they would. One month later, the Saudi’s are reversing and decreasing production. Many say this was a political statement geared towards the US. If the Saudi’s decide to begin to take anything for their oil, it would really put a dent in the petrodollar system.
With the US dollar breaking out and continuing its uptrend, things are progressing towards the ‘end game’. Money is running into the dollar due to safety, but I believe we can argue that European and Asian wealth is heading into the reserve currency. Look at what is happening in those continents and their currencies.
The Euro makes up a significant portion of the dollar index (DXY) and naturally the EURUSD has a negative correlation with DXY. We have seen the Euro hit parity and lower against the US dollar. The Euro hasn’t been this weak since 2002.
I can go on and show you all the currency pair charts with the US dollar. AUDUSD, NZDUSD, USDCHF, GBPUSD etc. Every currency is getting ‘rekt’. The dollar is gaining against all of these currencies. For Canadians, the Loonie is at 2020 levels against the US dollar. The interesting aspect is that both central banks are hawkish and are at 3.25%, but the dollar is ripping against the Loonie. One consequence of a stronger dollar will be that hawkish central banks will not be able to affect their currencies. This goes into the whole concept of a currency war between central banks. And a potential confidence crisis in central banks.
The central bank which is making current headlines is the Bank of Japan.
The Yen is getting clapped. Hasn’t been this weak since 1998. The Bank of Japan has kept interest rates at -0.1% while many other central banks have raised interest rates multiple times. In terms of interest rate differentials, it is a good trade to buy pretty much any currency versus the Japanese Yen. With higher interest, you even make money holding overnight on swaps. Short the Yen (long USDJPY) is a popular macro trade, and some say is the Fed trade.
The Bank of Japan made a big move yesterday. They announced a currency intervention. The Bank of Japan will intervene in an attempt to strengthen the Yen. This is huge.
Mainstream media reports that this has not happened since 1998. But there is a big difference. Back in 1998, the Bank of Japan and the Fed did a coordinated intervention. This time, the Bank of Japan is doing this without US approval. They did ask the US for an intervention months ago but the US Treasury declined. Now the treasury says they understand why Japan did this.
Why is this important? Well, Japan must sell off foreign reserves to buy Yen. Japan will have to sell off US treasuries and Dollars. Remember that Japan, and not China, is the largest holder of US treasuries. Selling off treasuries will in effect cause US yields to rise, which will put more pressure on stocks. Everything is connected.
This is big because even US allies may be taking steps to combat the stronger dollar, and this will only become more apparent as the dollar strengthens. Allied currencies get hit and some may even find Russian energy more attractive since they will be able to use their own currency, rather than the expensive US dollar, for energy payments.
There are some who say that the US dollar rising is good for US hegemony. If the dollar is the only thing rising while everything else (stocks, bonds, real estate, currencies) are falling, then nations will choose to hold their dollar reserves. It keeps dollar demand high. The potential blowback is that allied nations gang up on the US and ask for another plaza accord in order to devalue the dollar.
This seems to be the direction we are heading towards and why this current dollar rise is super important. Keep your eyes on that dollar wrecking ball. I still see more highs ahead with the next major resistance coming in at the 117 level. The DXY is currently at 112.79.
Before I go, a few words for my crypto and precious metal bulls. The rising dollar will sink these markets.
Bitcoin is struggling to hold this major support. A breakdown sees a move back to $12,000.
While gold has already broken below the major support zone at $1680. There was hope for a turnaround as gold did not continue lower post Fed. However, we are now seeing the breakdown and continuation with today’s price action. A stronger dollar could see gold head back to $1500.