Throttle Up

Written by Bruce J. Clark

April 24, 2019

You would be forgiven for thinking that the title of this piece referred to the new record high in the S&P. The index is up more than 25% since the December lows and investors still can’t get enough, driven by better than expected Q1 corporate earnings mixed with a healthy dose of FOMO…fear of missing out. So far they’re not wrong.

Rather, it’s the US dollar that feels like it’s about to go on a run higher. Perhaps significantly so. The dollar index (DXY) stands at its best level in almost two years. The US economy may have hit a wall late last year but it appears to have since blasted right through. Tuesday’s report of new home sales is more evidence of good news that continues to pile up (chart below.) The US is again proving itself to be a bastion of strength in a world full of uncertainty, and that is being reflected in demand for its currency.

But a launch in the dollar sets up a potential conflict with the current euphoria in the asset markets. A stronger dollar tends to suppress commodity prices, creating deflationary headwinds while most central bankers are still struggling unsuccessfully to generate higher prices.

It’s also likely to cause some serious problems for countries with large amounts of dollar debt, especially among emerging economies. Memories are still fresh from 2018 when similarly uneven global economic conditions spurred the dollar, squeezing the finances of countries like Brazil, India, Turkey, South Africa, Russia and even China, sending their markets falling like dominoes and eventually impacting developed regions.

The u-turn in Fed policy in December brought relief by temporarily capping the dollar and helping many markets to recover. The key word here is “temporarily”. As the dollar finds fresh legs it will serve as an unpleasant reminder that the underlying problem of massive negative exposure to the buck abroad hasn’t gone away. This piece in the Wall St Journal today certainly raised some eyebrows: “China’s banks are running out of dollars.”

Smelling trouble, the emerging markets are beginning to weaken. We have a good idea of what happens next. If the dollar is on the move, which appears to be the case, it’s time to give your seat on the equity bandwagon away to someone else.