Tuesday, April 14, 2015

Implications of a Dollar Reversal

The big consensus trade that is on right now is the strong dollar trade.  If there is a reversal of that consensus trade, and the dollar weakens here are a few of the implications:

1) Weaker European equities.  Counterintuitively, weak US economic data leading to a weaker dollar and a more dovish Fed will be more bearish for European equities than US equities.  This is why European equities will be the nexus for upcoming equity weakness, because the biggest potential catalyst for equity weakness is a weakening US economy.  The other global economies are so moribund, not much is expected from them.

2)  Lower global interest rates.  The one catalyst keeping traders from going all in on Treasuries is the potential for Fed rate hikes.  A weaker dollar would be a sign that the US economy is not strong enough for rate hikes, thus pushing money from equities into bonds.

3)  Weaker Japanese equities.  For the same reason as noted above with European equities, as a stronger yen is the kryptonite of Japanese equities.

4) Hedge fund panic.  The hedge funds are heavily betting against the euro, and for a stronger dollar.  A weaker dollar would wreak havoc on their returns.  This could lead to collateral selling of their favored positions, which is European and Japanese equities.

5) Yield curve steepening.  The weak dollar would be a sign of lower for longer, and the front and the belly of the curve would be the biggest beneficiary of a weaker dollar.

By the way, I am not calling for a weaker dollar, but the strong dollar theme is long term unsustainable given the purchase power parity and trade flows.

No comments: