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Keep An Eye On DXY

Jul. 30, 2020 5:05 PM ET
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  • The dollar Index has declined over 10% since the March sell off.
  • The FED's moves to push investors into risk assets continues to hamper demand.
  • Negative real yields threaten to push DXY lower as foreigners opt for commodities.

The Dollar Index (DXY), which measures the USD against a basket of foreign currencies, including the Euro and Yen, has fallen over 10% since it's high in March. This is the first time in over two years that DXY has crossed below 93, which is a major point of resistance on the chart. While risk assets continue to rocket higher thanks to the FED backstop, the dollar poises a major risk as it continues to decline. 

Since the March lows, thanks to relentless intervention including loading up on treasuries, junk bond ETF's, and even individual corporate bonds, the FED was able to put a floor in the stock market. Investors sentiment was calmed, and people made the decision to not sell their positions in US equities, but rather buyers emerged as they knew the FED has their back. However, pushing investors in to risk assets requires them to exit low risk assets, such as cash and treasuries, which are the backbones of the US dollar. This has caused a major reversal in the USD, which has been bid up to over 102 during the peak of the market crash. The DXY has crossed below 93, and reverse correlated assets like gold and silver have skyrocketed. 

The real risk to the US economy I see is a continued decline on the DXY. With the FED putting themselves in a corner, they have no choice but to continue to prop up the stock and bond markets. These moves reinforce lower lows on the DXY, as investors will continue to sell safe haven assets to pile into stocks and bonds. Another concern I have is negative real yields. With the ten year at 60 basis points, that is well under even the understated CPI target of around 5% per year. Investors are loosing money holding long term treasuries. As of now, since institutions don't have many other options as bonds in Europe are paying negative rates, they have shown a  willingness to hold these bonds. However, if inflation picks up on the CPI (real inflation has been picking up in important sectors for decades, but the CPI is designed to not catch it), you have to believe many large investors will look to exit treasuries. Though the FED will haver to buy the bonds to make sure rates stay low, that would just produce more inflation, locking the dollar in a death spiral. 

I continue to be quite bearish on the dollar medium term. While I don't forecast it loosing its reserve currency status like many others, rapid inflation is long overdue, and it would have dire consequences for the USD and the entire economy. Although the Fed will buy bonds if they sell off to compensate for higher risk premiums necessary for inflation, that would just cause more inflation that goes with an expanded balance sheet. My advise to investors out there is to do your due diligence and block out the noise from the mainstream media. 

Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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