Just prior to the March 18, FOMC meeting, the US dollar index, DXY, put in its highest mark in 12 years, 100.39 on March 13.  Since the March 18 FOMC and Yellen’s dovish press conference, the dollar has stalled and given ground versus both major and EM currencies.  Late Tuesday DXY was 97.19. As of now we’d characterize this as a pullback in a bullish trend.

Almost everything seems to have been driven, at least in part, by dollar strength since late last year.  The flip side of course, is relative weakness of other major currencies due to the mess in the Eurozone with the possible exit of Greece, and the de facto Japanese yen depreciation through QE, along with very low to negative interest rates in many parts of the world.  I believe that much of the strength in US assets, in both stocks and longer dated treasuries, has had to do with foreign capital flows and a desire to somehow preserve purchasing power.  In skimming various news services I’ve seen over and over that wealthy Chinese are trying to get their money out of China, and that there has been (unsurprisingly) a run on Greek banks. 

Clearly the EURCHF peg broke because wealthy Europeans were so intent on moving wealth out of the euro.  Of course it fits … if the Italian ten year is yielding 1.32 (as it was Tuesday) and the US 10-year treasury yields 1.89, it makes sense for foreign investors to choose the US, especially if the dollar is constantly firming.  My further thesis, in part, is that dollar strength has perversely been supporting stocks.  I say perversely, because, as a Forbes article from Oct 2014 notes, the S&P500 “…relies on foreign sales for 33% of revenue…” and for the tech industry as a whole the number is 60%.  I used to always say that the US stock market loves a weaker dollar, but not anymore.

Obviously, as the dollar increases in relative value against everything else, products priced in dollars see more competition.  It becomes harder to sell US goods overseas, and on the domestic front, foreign producers have a price advantage.  However, if your currency has dropped 25% since May (like the Euro), and you can find US stocks that pay a dividend and are supported by the idea of an economy that has escape velocity, it’s a pretty simple decision, even if US earnings reports also see a negative impact due to currency translations. 

Note: Consider that in the early part of the “recovery,” the phrase “escape velocity” was regularly bandied about to describe the idea that government stimulus had given the economy enough of a push that it had forward inertia on its own.  Now that notion seems to have been downgraded in some sense, to “lift-off”.

Now let’s consider the value of the dollar in a longer term technical chart context. 

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The high in DXY was in 2001 at 121.00, the low in 2008 at 72.70 … seven years.  Now it’s seven years since the low, and we have neared the .618 retracement at 101.80, (the high this month as noted above, is 100.39).  The move higher has been fierce, and the long-dollar trade is crowded, to use popular market terminology. 

The Big Question

What if the Fed’s hawkish stance reverses?  What if the US economy has some of the same speculative excesses that caused the great unwind in 2007/2008?  The DXY could trade all the way down to 90, (or even 85) without violating the long-term base.  Could the US fall victim, to some degree, to the same fast capital outflows that have recently wreaked havoc on emerging markets?  In that case, both stocks and long bonds could move lower simultaneously.  I’m not making a prediction here, although if you want a sobering one, go no farther than the Atlanta Fed’s GDP Now estimate for Q1 GDP of 0.3%. 

What I am suggesting is that protection through various option strategies makes sense, given continued uncertainty across the globe.   “For all the Ifs in life”, as the insurance ad says …       

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