September 25

Awaiting the Dollar Correction

The US Dollar came under pressure today during the New York session, mainly against the Euro and Yen.  The fall in the Dollar occurred simultaneously with a selloff in equities and a blowout in high yield credit spreads. While the move has been small so far, many market participants have been waiting for the Buck to take a breather before continuing it’s trend higher. Today’s selloff in the S&P 500 has shown traders clues about where FX markets could be headed next.

The prominent Dollar rally over the last couple of months has prevailed during a mostly risk on environment. Equities have moved higher along with the Dollar. In just the last couple of weeks the Greenback rally broadened out to hit higher yielding currencies and emerging markets.  It is clear that the US dollar is in an uptrend, but the move is looking especially stretched versus the Euro and Yen. The large declines in these currencies are likely to finally stoke the inflation that the BoJ and ECB are seeking to create.

As inflation rebounds in Japan and the Eurozone, each respective central bank will be under less pressure to add to easy money policy. Given that the market has seemlingly already priced in an over 50% chance of ECB QE, the implications of inflation rebounding are extremely key for the Euro. Japan’s CPI data is out this evening, and the Eurozone’s flash CPI estimate is out early next week. On the other side of the equation is the picture for the US Dollar. NY Fed president Bill Dudley voiced mild concerns yesterday about the Dollar rally impacting the Fed’s ability to reach it’s mandates saying “If the dollar were to strengthen a lot, it would have consequences for growth,”

Taking into account today’s market activity, a declining stock market is very likely to impact the broader economy as Americans see a shrinking 401k balance while headlines about a plunging market will hurt consumer confidence. The wealth effect of a strong equity market has made an immeasurable positive impact on spending, and this could go into reverse if the S&P 500 makes a standard 10% correction.  Selling the Dollar against EUR and JPY is an expression of the idea that a stock market decline will lead to a slower pace of tightening from the Fed. The Dollar index will probably remain inversely correlated to the SPX as long as markets are on edge.