3. Dollar valuation somewhere in the stratosphere. Markets are arenas of action and reaction, dialectics of suppositions, beliefs and, yes, flawed assumptions. In Soros-speak, markets are “reflexive”: perceptions of reality—whether accurate or not—often distort underlying fundamentals themselves.
The U.S. dollar is today’s reflexive case in point. So positive has been the opinion toward the U.S. dollar that its value has been bid up to dangerous levels (see chart below). Now, like Icarus soaring too close to the sun, the dollar’s wings are melting. This has been especially problematic for corporate America. The strong dollar was a leading contributor to a fall in S&P 500 profits (ex-financials) of 3.6% year-on-year. Expect continued head winds.
4. Fed hawkishness priced in. Investors should commit and recommit to memory that Mr. Market is very good at discounting future events. What is already well known? That the actions of central banks have become predictable, even boring. Most importantly, investors know that the ECB and Bank of Japan will continue to aggressively expand their balance sheets. That explains the near 14-year high in the U.S. dollar and the nearly unprecedented cheapness of the Japanese yen.
This leaves the U.S. dollar highly vulnerable. Any hint of dovishness is likely to lead to a sell-off. The Fed can soften its tone in two key ways. First, communicating the speed and duration of its tightening cycle, along with its end point. The gradualism of the Fed and commitment to “lower for longer” is still underappreciated. The recent long bond rally is forecasting this trend. Second, any sell-off in global capital markets or economic slowdown (as we saw this summer) will cause the Fed to hit pause on further hikes. Either scenario is highly probable, but both dollar bearish.
The dollar has quietly displaced gold as the world’s new cult currency. But is this aging bull market logical and sustainable? Among 19th-century philosophers, Schopenhauer was among the first to contend that, at its core, the universe is not a rational place. With high overvaluation, negative momentum and capital outflows increasing, the rationality of an ultra-long U.S. dollar position should be held in question.
Like other asset classes, currencies have a history of heading into extremes. The U.S. dollar could certainly move higher from here. But it is a crowded place and the stakes are enormously high.
Tyler Mordy, president and chief investment officer of Forstrong Global, is a recognized innovator in the design and application of global macro ETF managed portfolios. He is widely interviewed by the financial media for his global investment strategy views, as well as ETF trends. CNBC has called him one of the “best independent ETF experts.”