Dollars, rates, risk, and 2002

Following up on the greenback

Yesterday, I noted that the USD appeared poised to move lower—potentially back toward the bottom of its pre-pandemic range around 96. Part of the basis for that view comes from the chart below, which is a long-term model I use to track dollar trends. As shown, the three lines clustered between 99 and 101 suggest a key pivot or equilibrium zone for the Dollar Index, and the dollar has moved below that range so far this month. Another notable aspect of this chart—and one that suggests the world remains flush with liquidity—is the continued rise in liquidity (i.e., more dollars), which has done little to stem the climb in the USD since the Global Financial Crisis.

In short, as liquidity levels rise, one might expect the USD to decline due to the sheer increase in the supply of dollars. However, demand for USD-denominated assets has been so strong that it has instead driven the dollar higher. Now, with the dollar starting to slide, is the greenback finally responding to the massive liquidity in the U.S. financial system and the growing imbalance between federal revenue and debt? That’s a question without a clear answer—but certainly food for thought this Wednesday.

While liquidity impacts the USD, 10s watch

In 2022, the USD peaked, as shown in the previous chart. That same year, the 10-year yield resumed its climb from the 2020 pandemic lows, as the economy stabilized and inflationary pressures intensified. The Fed—having waited too long—began its rate-hiking campaign in the spring. It also started tightening liquidity through various measures, which reduced available demand for assets, leading the S&P to tumble while long-term rates rose. When liquidity bottomed in 2022, the 10-year yield fell as demand for risk assets increased. This rise in asset prices spurred greater retail spending, pushing inflation pressures further higher and reinforcing upward momentum across markets.

Since late 2022 and into 2023—following the start of the rally that carried through the end of 2024—10-year yields have remained largely range-bound, with the 13-month moving average essentially flat since early last year. The recent rise in liquidity, which helped fuel the equity market rebound, has likely kept a lid on selling in 10-year notes. But what happens if dollar weakness accelerates and liquidity levels stop rising? That scenario could very well push yields through the top of the range at 4.70%.

Looking back to 2002

While researching for this note, I was struck by the similarities between the USD in 2002 and today. After the tech bubble burst in 2000, the dollar rallied for two years before collapsing over the next eight. That period of capital flight and wealth destruction across the economy contributed to numerous side effects—most notably, the Global Financial Crisis. But before that crisis unfolded, the dollar’s collapse from the 120s to the low 70s was followed by significant outperformance in foreign markets relative to the U.S. and a massive commodity rally, particularly in gold (as shown below). Gold, which bottomed at $256 in 2001, rallied to $1,030 by 2008 (and even further into 2011) before beginning a decline. Does this suggest that the $2,500 level we recently saw in gold—and current levels—are just the beginning of another long-term run?

Honestly, I’m not a gold trader, so I can’t say for certain—but the similarities between the two periods are notable. The CRB Index also bottomed in 2002 and moved higher for the following nine years. If this is indeed the beginning of a downtrend in the greenback, perhaps the 2002–2011 playbook will come back into focus. Also, if the CRB happens to climb like it did during that period, the inflation story will very much move to the forefront once again.

But models don’t always align

While I can speculate on 2002, breakouts in rates, or breakdowns in the USD, let’s take a step back and examine the current conditions in the equity markets—which may be more revealing at the moment in relation to the USD and the 10-year yield. The chart here shows three variables: the S&P, my proprietary risk index, and a market conditions model I developed years ago. Risk flatlined heading into year-end and began to decline before the equity market crash this spring. Market conditions followed a similar path. Although initial signs were noticed, selling began well before “liberation day” in April. While the S&P has rebounded sharply over the past month, both risk and market conditions have tightened.

This serves as a “flag on the field,” so to speak, for the equity trend. As long as this persists, the S&P becomes increasingly vulnerable to a pullback—and given the elevated level of chatter in global markets today, developments like this could quickly upend sentiment. With that in mind, perhaps the move in gold reflects a hedge against such risks, while the buying in 10-year Treasurys—despite flat liquidity—represents a flight to safety. Similarly, risk assets may be positioning for another leg down in the USD.

There’s a lot of noise in the markets right now. More on that in the days ahead.