Negative Yields and Strong Dollars
Negative Yields and Strong Dollars
Strength of the Dollar and Commodity Prices
Today is a particularly interesting day to ignore technical trading for a moment and focus our attention on the fundamentals, namely the macro economic effects on the market. The above chart illustrates the Dollar index over the past year. The movement of the Dollar since the credit crisis began to become pronounced and the government has stepped in and loosened its monetary policy had been dramatic, but counter intuitive to traditional economic thought. Paul Volcker gave us a powerful lesson during his tenure as Chairman of the Federal Reserve and wielded the Feds ability to raise interest rates and tighten fiscal policy and thus strengthen the Dollar as a powerful tool to combat inflation. However, this time, we’re witnessing rate cuts and government cash infusions on record levels, while at the same time, witnessing a dramatic strengthening of the Dollar against major currencies worldwide (Yen excluded). What’s going on?
A couple things. First, the panic in the market has caused funds worldwide to get massive calls for redemptions from investors. This call for redemptions has obviously impacted nearly every asset class, but it has created an enormous demand for the Dollars as investors turn to cash and treasuries for security. The Treasury story has become the most recent bubble. Two days ago, for the first time in history, investors clamored for safe havens so dramatically that 3 month T-Bills now have negative yields. So, to account for the strength in the Dollar, not only do we have mass redemptions from investment funds, but rather than cycle the money back into the economy and the market, investors have fled to the relative security of the bond market.
The effects of this are plain to see in the commodities market as well. Below are a couple charts.
Kansas City Wheat
Crude Oil
Remember back in July when we had record oil and wheat prices? At the same time, many OPEC members were blaming the record prices on the weakness of the Dollar and called for a change, namely that oil in the future, be denominated in Euros. December is a different story. Six months ago, the relative strength of the Dollar that we see today would have been a laughable absurdity, today however, this reality is a big reason for the decline in all Dollar denominated commodities and the Dollar Index chart is nearly a mirror opposite of the two commodities charts.
What’s Next? The timing is uncertain, but the fact of the matter is that the bond market is an absolute bubble based on fear. As we mentioned on December 1st, investors can’t sit on the sidelines forever and once we see Treasury yields increase, we should see inflation begin to become a factor, leading to the correlating increases in commodity prices across the board. We’re Bullish long term on commodities and expect the commodities markets to lead the equities markets in making a recovery.
Friday, December 12, 2008
Think like a Fundamentalist, Trade like a Chartist.