Near Term, The Dollar Is The New VIX

| About: iPath S&P (VXX)

Summary

The dollar may tell a better story than the VIX.

The US claims to be in selling dollars to the world.

If the dollar can't weaken, it's a sign of stock selling.

We're all trying to understand how much risk is in the world right now. We think watching the dollar is a powerful measure to understand risk. We typically love watching the VIX (NYSEARCA:VXX) as a risk indicator. That said, we are watching the dollar (NYSEARCA:UUP) to let us know how markets follow through.

Fed Selling Dollars

The Fed made a strong statement of support for foreign government currencies. They appear to offer a large supply of dollars in the market to support other currencies. If it doesn't work you have a signal how much concern is in the market. We expect that concern to translate into stock prices.

The Fed said this Friday, "The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy."

The Dollar Should Go Down With Supply, Unless Worry Is High

If the dollar price is going up despite the Fed supply (versus the euro), we think that means further risk.

Here's the euro versus the dollar which we think speaks to the most important story for markets. We think this relationship is the new VIX for the near term.

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Here's the euro continuing to trade weak day 2.

Close up we see lower lows with a flat bottom telling us there could be more risk.

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This is very short term but we think it matters and will help determine where markets end up going in the short run.

This is important because (as we said in our Sunday weekly) we think liquidity may be light going into July 4th weekend so direction might see pile-on which will end up defining the story of markets following Brexit.

We're focused on the euro more than the pound because it is much larger in volume and represents a larger base of opinions. If the world can't cause it to stop falling the Fed may need to get more aggressive, which is likely not what they want.

If Too Many Dollars Are Needed It Could Cause Competitive Currency Devaluation

If the US is too aggressive it could cause competitive devaluations as other countries protect their currencies.

The Japan finance minister has already said, "I was instructed by the prime minister to take various, aggressive responses" as reported by CNBC.

Thus, if the euro holds there is much less risk in the markets. If not, there is building risk in the markets. That's why we think it's the critical measure to watch.

If the euro doesn't level out it's a sign that markets can drop further. We think if that happens the Fed may try to come in with a new round of support. The more support the more we see it as inflationary and a risk for other countries to compete and devalue.

Here's the VIX

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While we do think the VIX would rise if the market falls, we don't think it will predict a fall.

The dollar strength though will predict a fall and the VIX would follow higher. That's why we're watching the dollar.

We think the dollar shows the ultimate demand for stocks by foreigners. If they are pulling in and worried they likely continue to sell stocks.

Dollar is still diverged from markets making this an issue

We've been saying for a long time that the markets diverged from the dollar. On one hand the euro divergence is catching up. On the other hand the Yen divergence is widening.

This is divergence. We've said for a while this likely means lower US markets (June 2: Dollars Mercy, June 4: Dollar Diverge From Market An Early Warning Sign).

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As dollars flood into the market this dollar/yen relationship gets worse. The tight correlation to the S&P 500 ETF (NYSEARCA:SPY) has diverged and is getting worse.

Japan is one of the largest investors in the US. We've been saying for some time that foreign investment demand in the US is slowing.

The US chart in foreign currency is breaking down to foreign investors which can cause them to sell further.

Conclusion

We see some of the dollar pressure on markets playing out. We are using the dollar as an indicator for where risk stands (with the euro) and where the US market can go on the downside (with the yen).

We are bearish.

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Disclosure: I am/we are short ES, BUT THAT CAN CHANGE AT ANY TIME.

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