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Greenback and equities at critical crossroads

18 August 2020

No news is bad news for the world’s reserve currency lately, which continues to surrender ground even without any noteworthy developments, pressured by the ‘risk on’ atmosphere in the markets. Unless investors are in a truly defensive mood, the greenback is struggling to find any love these days.

There are several elements behind this. The US recovery likely lost steam thanks to the spike in infections, which in turn is fueling bets for an even more aggressive Fed and undercutting what little yield advantage the greenback has left. Worries that Congress might not deliver enough stimulus to kickstart growth may also be playing a part, alongside some election uncertainty.

That said, the dollar has already declined quite substantially, speculative short positions are near extreme levels, and new virus cases in the US are coming down while Europe is in the early stages of a second wave. All this argues for a correction in euro/dollar, which is currently testing $1.19, a region that has rejected the pair twice already. The near-term fortunes of the entire currency market might hinge on whether we see a break higher or another rejection.

Nasdaq resumes its old ways, S&P not as fortunate

The stock market is an entirely different story, since the tsunami of liquidity that has been unleashed by the world’s central banks is forcing investors to rotate away from bonds that yield almost nothing, leaving equities as the only alternative that still provides any return.

The tech-heavy Nasdaq (+1%) set another record on Monday, with the likes of Nvidia and Tesla being at the tip of the spear. But aside from the high-flying tech sector that investors have fallen in love with, the broader market wasn’t as cheerful. The S&P 500 rose only 0.3%, capped by its previous record high once again.

The inability of the index to break higher speaks to some caution among investors, who may be getting cold feet increasing their risk exposure any further with so many unknowns still flying around. This is another crucial test for financial markets. A new record in the S&P would send a strong signal that risk appetite is the only game in town, whereas a rejection would imply traders are not ready to go ‘all in’ yet, setting the stage for a corrective trip lower, particularly if Congress continues to dither and delay.

Yields drop, yen and gold cheer

A spike in global bond yields tormented the yen and gold last week but all that is turning around, as yields are back on the decline. The Bank of Japan has a yield curve control strategy in place that effectively keeps a ceiling on Japanese yields, so the yen suffers as global yields rise but shines as they decline. This is part of what makes it a safe haven.

In the precious metals arena, gold got a lift both from tumbling yields and a weaker greenback, crossing back above the $2000/ounce region today. Despite last week’s correction, the factors that brought bullion to the dance are still present. Central banks and deficits remain in play, there’s a US election coming up, and tensions with China are getting worse.

The overall trajectory therefore still seems higher, especially since the Fed won’t allow the biggest downside risk for gold to materialize: substantially higher bond yields.

Elsewhere, the kiwi remains a laggard, unable to gain ground even against a battered US dollar after the RBNZ went ‘all out’ with its dovish messages. So long as the RBNZ threatens negative interest rates and foreign asset purchases, the kiwi will likely struggle, particularly against currencies with ‘steady’ central banks behind them like the aussie.



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