It’s Still a Dollar Story

Any way you slice it, it all still comes down to the dollar.

We can talk about interest rates, the Yen, and inversions – there are all kinds of interesting relationships…

But none of them may be as important as the impact the direction of the U.S.Dollar has on risk assets around the world.

I know, I know…

I’ve written about this enough that you’re sick of hearing it. But it’s that important!

It’s undeniable.

Let’s start with a look at the DXY falling from recent highs in the upper pane, and in the lower pane, the USD on a relative basis compared to various currency pairs illustrating the strength out of the Dollar.

This RS line indicates the USD isn’t just doing well against the Euro and the Yen – it’s doing well against most other currencies as well.

What’s the impact on risk assets? Take a look at these equity returns as the USD slid.

Coincidence? I don’t think so.

So here we have it… coming into August 1, we have the USD falling off by only 3% and we’re seeing monster moves in equities…

Transports are up over 8%
Mid-caps are up over 9%
Small-caps and large-caps are all doing very well

That’s happening in an environment where the USD has fallen just a little bit (3%).

So what’s going on?

The Greenback has become this year’s safe-haven trade. That’s pushed the dollar to its highest levels in decades.

And why not – where are investors going to go?

Stocks have been beating up all year, off to their worst start in the last 50 years. And Bonds have been off to their worst start ever.

And even the Japanese Yen, another traditional safe haven, has been awful.

That’s left the USD to act as the safety trade.

There has been no other safe haven.

And what do we know about a strong USD? It acts as a serious headwind against global growth stocks.

So here’s the math…

A strong dollar means stocks down. A weak dollar is good for stocks.

Not hard to grasp right?

So if money is leaving that safe haven (USD), which is what was happening the last few weeks, it’s going somewhere.

It’s being put to work in Equities.

And how are Equities doing when the USD retreats? Pretty damn good by the look of things.

We just saw three consecutive days where the S&P 500 gained more than 1% a day. I’d say that’s pretty good.

Look back at that chart above – those are what we call rippers! Some serious gains off of pullbacks in the dollar.

Here’s another way to look at this. Take a look at this chart comparing the USD to Emerging Market Currencies on a relative basis.

The dollar peaked in 2015 and in 2020 versus Emerging Market Currencies. What happened to the USD at these very same levels in 2015 and again in 2020?

Yep, it got turned back. And the way I learned it…

From failed moves, come fast moves in the opposite direction.

So, unless this time is different, we could see a USD reversal here yet again.

What happened to stocks (SPX) when the dollar fell relative to EM currencies?

Look at the chart below comparing Emerging Market Currencies using WisdomTree Emerging Currency Strategy Fund (CEW) and the S&P 500 index (SPX). Pay attention to the former lows in Emerging Market Currencies compared to the lows of the S&P 500.

In 2016 and 2020, both these indexes bottomed around the same time before experiencing significant uptrends. And here we are with EM currencies back at the scene of the crime…

Could we see similar price action as we have in the past? Is three a charm?

If these critical levels in CEW can’t hold and investors see a break below former lows, then that’s likely happening in an environment where stocks are under pressure making new lows as well.

Investors will want to continue to follow the USD and its relationships for any signs of renewed strength or further deterioration…

Your key may very well be the U.S. Dollar.

Until next time, invest wisely, friends…