Outlook

The latest war news from the Middle East may have almost evaporated, but everyone knows it ain’t over. We are leery of the supposed inverse correlation of the S&P and the dollar index—it’s not ironclad and has plenty of exceptions—but this time, with the S&P likely to hit a full six days of losses for the first time since 2022, as Reuters notes, “there's clear anxiety building on Wall Street. With the S&P500 now off 5% from record highs in less than three weeks, the VIX 'fear gauge' of implied volatility soared above 20 on Friday for the first time since October.”

FX market players like to pretend the equity indices don’t matter all that much and it’s the 2 and 10-year yields that rule the waves, but in time of crisis, sentiment about equities does influence sentiment about currencies. Contributing to doubts about US equities are glitches in some earnings and whether Big Tech is a bubble. Sell in May and go away? Actually, this has worked 15 of the last 20 years.

In addition, the US is under attack from the usual suspects, including Brazil, for high rates and too-strong dollar impoverishing the emerging markets. Snotty comments keep coming from the IMF and G20 members in Washington, including snipes at “industrial policy” (by which they hypocritically mean subsidies) and tariffs. The rest of the world is also ticked off that the US is getting away with levels of sovereign indebtedness considered excessive historically that would drive anyone else’s currency way, way down.

According to Bloomberg, “US debt held by the public is expected to reach $48.3 trillion, or 116% of GDP by 2034, up from 97% at the end of 2023, according to the Congressional Budget Office.”

Why this doesn’t harm the dollar is a mystery and can only be attributed to what France griped about in the 1970’s—“exorbitant privilege” of the hegemon (biggest economy, biggest military, reserve currency). The world has been free to name or invent a different reserve currency and has failed for 40 years.

We had thought the charts showed a traditional, normal pushback against the too-strong dollar on Big Player position adjustment alone. But it has been squashed, probably.

Forecast: The latest news from the Middle East is the stuff “from left field” that upsets a forecast, although this time it was short-lived. The corrective move against the too-strong dollar wasn’t really stopped in the tracks, but got a dose of cold water in the face.

An even bigger contributor is the ongoing rise in the yields, with an increasing number of big investors speaking of higher for longer. When the 2-year is nearly at 5%, the long-term average S&P dividend yield at 1.84% looks puny. Today it’s 1.35%.

We are in the minority and maybe even contrarian to see the Fed determined to cut rates if it possibly can. Trend-followers do not like taking a contrarian stance, and most lily-livered economists would also rather go with the flow. But the Fed wants to avoid being totally wrong about inflation trending down. It wants to see the yield curve normalized and if also wants to avoid being seen to do anything around the time of the Nov 5 presidential election, let alone after it. It wouldn’t mind helping the housing market and off on the side, not upsetting the equity applecart, too.

To stick to this point of view, we need to see the Feds stop talking about not being in any hurry to cut (NY Fed Williams) and the like. We have to wait for more data that permits less hawkish remarks. In the meanwhile, we have to expect the dollar to hang on to gains, subject to the usual position-adjustment hills and valleys.


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