Dollar clears the way upwards, and Fed may spread turbulence in the market

A collapse is developing in Chinese markets following the continued tightening of regulations on large technology companies. The Hang Seng index has lost all its gains from November last year, losing more than 10% in three days. But investors still see these fluctuations as a local story while US indices update all-time highs on Monday. European indices and US index futures are slightly down today.

However, investors in much of the world should not ignore this decline. All too often, the initial problems in China have set off a chain reaction in world markets. This applies both to the US-China trade disputes and the coronavirus recession, which developed markets ignored for more than a month before the violent sell-off of February 2020 began.

Notably, the increased volatility in the Chinese market has removed one of the last obstacles to declaring a bullish recovery in the dollar and traction in defensive assets in equity markets. The USDCNH pair crossed the 200-day moving average today.

In our view, the bullish trend in US equities is mainly due to inactivity, with investors selling off the Chinese market and buying the US market. But history has taught us reliably in recent years that globalisation has caused markets to shift very quickly into a sell-off mode with sustained pressure on a single major market.

Investors should pay attention not only to falling Chinese equities but also to the general pull into defensive assets in the form of falling developed country government bond yields. And all this despite the expectation that the Fed will discuss a tapering of stimulus, which in normal times would put pressure on bonds and increase their yields.

This correlation cannot be ignored by the Fed, whose monetary policy meeting is due later this week. The wide eyes of the American central bank on hidden market trends could radically strengthen and expand the pulling into protective assets in the form of a sell-off in equities and a further appreciation of the dollar.

There are increasing signs that the dollar is clearing its way upwards, proving its status as a haven currency in times of financial market turbulence. The Fed can mitigate this turbulence or give reasons to intensify it in case there are hints that stimulus is about to be withdrawn.