Divining the Next Crisis: All Eyes on the Dollar

 |  Includes: DIA, QQQ, SPY, UDN, UUP
by: Graham Summers

As I wrote earlier this year, the US’s monetary policy has already sown the seeds of the next Crisis. It is now no longer a question whether or not another Crisis is coming; instead, it’s a question of which Crisis and when. I’ve detailed what I think are the three general options below:

Quite a few people wrote me last week telling me I was insane for even claiming that the US Dollar could rally. But, in reality, this is the outcome Americans should all be praying for given the alternatives. A Dollar rally would only damage stocks and commodities, whereas a Currency Crisis would effectively destroy the economy and a Country crisis… well, that one is obvious.

Stocks generally get all the attention from the media. But, in reality, they are relatively small fry compared to the Bond and Currency markets. As of 2008, the world stock market was roughly $36 trillion in size. In contrast, bonds were $67 trillion and forex (currency) which turns over $3.2 trillion per day -- ten times the daily volume of every stock market in the world.

Suffice it to say, a Crisis in stocks would be the lesser of three Crises. And those of us in the US should be hoping it’s the Crisis we get as opposed to a Crisis for US debt or the Dollar.

The good news is that it seems this is what we’re heading for. In the last two weeks, the US Dollar broke its downtrend:

And stocks broke their uptrend:

I also want to point out that the Wilshire Index (the index containing every publicly traded US company) broke below its uptrend as opposed to the downtrend set by the beginning of this bear market (2007-present):

Looking at these, it seems that Crisis #1 (stocks collapse and the Dollar/ Treasuries) rally is the most likely candidate for the upcoming Crisis. However, to be sure of this, we need to see long-term Treasuries hold their 20+ year uptrend.

As I’ve written before, the Federal Reserve accounted for nearly half (49%) of all Treasury purchases in the second quarter. During the same time period, foreign investors (China, Japan etc.) decreased their purchases of US debt by 40%.

In simple terms, foreign investors are not interested in buying US Treasuries at current yields (with the 30-year yielding 4.4% and the Dollar losing 15% in value this year alone, I can’t say I blame them).

Now, to get higher yields you need bond prices to fall. The Fed’s Quantitative Easing program (in which the Fed bought Treasuries to artificially create demand) just ended… so we’re about to find out what the bond market thinks of US debt without life support. If demand is so low that Treasuries break their 20-plus year trend-line, then look out, we may be heading for Crisis #2 or Crisis #3.

Looking at a close-up of the 30-year’s chart, it looks like we’ll know the deal (whether bonds will collapse along with stocks) sooner rather than later.

In conclusion, my main point is this: It’s now certain that a Crisis is coming… it’s now just a question of which one and when. So far it looks like it will be a Stock Crisis (a replay of last year in which the Dollar rallies and commodities and stocks fall). However, don't get too caught up watching stocks right now. The bond market is larger and much more significant in terms of forecasting what’s to come. And with the Fed’s artificial support for Treasuries just ended, we may be about to find out.

Keep your eyes on the long end of the Treasury market and the Dollar. They (not stocks) will be dictating what’s to come.