The greenback makes a comeback

A weak US dollar is usually a good thing for stocks, says John Stepek. So it will be interesting to see how much higher it can go before it impacts on earnings.


The rise in the dollar: more than a dead-cat bounce
(Image credit: 2016 Photothek)

It's been a much more interesting week in terms of shifts in the asset prices we're monitoring. To put you in the picture, if you're new to this particular weekly column, I've picked out a group of charts that I think will help us to keep a close eye on what's going on in the world and what the key trends are.

This week, a few key economic events have made some changes in direction clearer the US dollar, for example, increasingly appears to be making a comeback, as opposed to a dead-cat bounce.

That's got to be interesting for the stock market a weak US dollar is usually a good thing for stocks, so we'll see how much higher it can go before the impact on earnings starts to show through.

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Anyway, here's what's been going on. For starters, the European Central Bank (ECB) held its latest monetary policy meeting on Thursday. For some reason, the market still has this tendency to imagine that ECB boss Mario Draghi might turn hawkish. This goes against pretty much everything that Draghi has been trying to achieve since mid-2012.

Draghi knows that once he stops quantitative easing (QE) or turns a corner, he'll be struggling to hold back the German contingent, let alone having any chance of reversing course if he starts to run into trouble. So you should be betting on him keeping policy as loose as he possibly can for as long as he possibly can.

On Thursday, the ECB announced that its QE will be halved to €30bn a month from the end of this year. But it also kept the programme open-ended, and said that it could ramp it up again if necessary. That was different to what was expected, and as a result, the euro slid.

Meanwhile, the race for Federal Reserve governor is hotting up, with markets wondering who might get picked to replace Janet Yellen (assuming that she isn't offered the job again, which she may well be). Investors are wondering if the replacement will be more hawkish than Yellen (I wouldn't bet on it a lot of them talk a big game, and then they get in the chair and realise that it's easier and more fun to keep the market sweet).

Finally, Donald Trump's tax plans finally looked as though they might be getting somewhere. Congress passed the budget on Thursday, which in turn clears the way for a tax reform plan to come out next week.

Markets like the idea of a big corporation tax cut, although the question of how it'll all be paid for is still keeping the deficit hawks in the US awake at night.

What the charts that matter can tell us this week

So what does it all mean for markets? First off,


had a rough week. This is very much a case of dollar strength we'll get to the reasons for that in a moment. My colleague Dominic Frisby has been calling this rather well in Money Morning recently. You can read his latest piece on gold from early September where he suggested that gold's rally above $1,300 an ounce could well be short-lived to get his view on the key levels to watch for gold.


(Gold: three months)

The US dollar index a measure of the strength of the dollar against a basket of the currencies of its major trading partners spiked sharply higher this week. It's partly about the aforementioned tax cuts, but also has a lot more to do with the weakening euro (the euro makes up the biggest chunk of that currency basket). A rebounding dollar is something to keep a close eye upon. A stronger dollar effectively means tighter monetary policy around the globe.

If inflation fails to keep pace in other words, if the stronger dollar knocks inflation back down then we're likely to end up in another "red herring" inflation cycle, where it all comes back down again, similar to the disappointment that followed the "Trump bump" earlier this year.


(DXY: three months)

One sign that inflation might end up enduring for longer is that the yield on ten-year US Treasury bonds has risen sharply above the 2.4% mark. That's starting to be seen as a line in the sand by technical analysts. Jeff Gundlach (the current "bond king"), reckons that if 3% is hit this year (which would admittedly be a tall order), then the bond bull market is over. That's a big deal, given that the bond bull market is more than 30 years old.

The jump in yields was partly due to economic data coming in stronger over the week; partly due to suggestions that the next Federal Reserve chair might be a "hawk" (as I said, I'm still to be convinced on that one); and again, partly due to expectations that Trump's tax-cut agenda is finally gaining some traction.


(Ten-year US Treasury: three months)

Copper had a mixed week. It's holding on above $3 a lb but the strengthening dollar has capped its gains. It's worth remembering though, that a strengthening dollar is not all bad news for the miners many of their costs are in emerging market currencies, so if the dollar rises, it can offset any drop in the metal prices.


(Copper: three months)

Bitcoin has maintained and built on its impressive recent gains getting to the $6,000 a coin mark now. What interests me most about this is the fact that bitcoin really doesn't seem to be acting like an "anti-dollar" (it's very different to gold in that way).

That said, I still struggle with the level of excitement around cryptocurrencies my colleague Ben Judge wrote about "Ripple", which is one of the more established "new" cryptocurrencies, and the level of heated debate that erupted on Twitter around his piece is very much in the vein of a small-cap bulletin board circa 1999. (It's a good piece, by the way you can read it here.)


(Bitcoin: six months)

This week, weekly US jobless claims remained low. The four-week moving average slipped back to 239,500 as claims came in at 233,000, lower than the 235,000 expected. According to David Rosenberg of Gluskin Sheff, when US jobless claims hit a "cyclical trough" (as measured by the four-week moving average), a stockmarket peak is not far behind (on average 14 weeks), a recession follows about a year later.

So far, 20 May has been the cyclical trough, but the stockmarket keeps setting new peaks. And if the jobless claims stay around these levels, we're likely to see a lower trough before the end of November.


(Four-week moving average, US jobless claims, since 2014)

There was a big comeback for the oil price (as measured by Brent crude, the international/European benchmark) this week. It's challenging the $60 a barrel level again (that's the price at which everyone expects a never-ending gusher of shale oil to appear). If oil does take off again, it could make a big difference to the inflation picture, which would make things very interesting to put it delicately.


(Brent crude oil: three months)

Finally, there's Amazon. It's not on the chart below which only shows the price up to the close on Thursday, but the online retail and publishing giant surged back above $1,000 a share at the end of this week as it reported strong third quarter sales and earnings.

Sales rose to $43.7bn from $32.7bn for the same quarter last year. Meanwhile, net income came in at $256m compared to $252m. Jeff Bezos, Amazon's CEO, put the success down to sales of its Alexa voice-activated device. Its cloud-computing unit did extremely well too. Amazon is also now apparently getting into the pharmaceutical drugs distribution business in the US as well cue another industry quaking in its boots.

It'll be interesting to see how tech does from here, because Amazon wasn't the only forecast-beater Microsoft, Alphabet (Google) and Intel all beat hopes too.


(Amazon: three months)

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.