Are Investors Secretly Turning Bearish On The Dollar?

Less than two weeks into 2016 and history has already been made. This January will go down in the record books as Wall Street’s worst in decades. China is losing control, the Middle East is boiling over and the Emerging Markets are in dire straits. All of which has led stocks to shed more than a trillion dollars in value.

It’s the classic boiling-to-the-brim pot which suggests we’re ready to push the dollar higher, right? Instead, dollar strength has really been rather tame which, on the face of it, is quite puzzling. That is unless investors have secretly been turning bearish on the greenback. The question is, are they?

Dollar Bears Raising Their Heads

Demand for US Treasuries is surging; that we can tell by the collapse in bond yields. That is, of course, the signal of crowded purchases of US Treasuries by investors. With global stocks plunging investors, especially American investors, are likely liquidating their positions abroad and purchasing dollars.

Yet even so, the dollar index has barely budged, rising by only 0.8% in the past two weeks. Even the Euro has held up well against the greenback, holding above $1.07. This means that while there is a net dollar purchase, there are also many sellers. And the key reason for that is that some investors believe the US can’t continue to outshine the rest of the world. Eventually, growth must dip lower and US interest rates will remain stagnant from here on out.

That belief is being reinforced by the rather mild reaction to last week’s very robust non-farm payrolls figure. Though 292k new jobs were added, investors seem to believe that jobs are lagging and growth stultifying. Investors are focused on the latest weak ISM Manufacturing reading and the dip in GDP growth to 2.0% for the third quarter.

The conclusion investors are drawing is that global troubles are pulling down the US. The fact that Treasury bond yields fell across the bonds market only amplified their assumption that Fed rates won’t go higher. And if Fed rates don’t go higher the interest rate gap between the US and the rest of the world won’t be as steep as it now seems. If that is the case, then it’s time to cut back on dollar holdings.

The Good News And The Bad News

Although, intuitively, this might seem dollar negative that’s not necessarily the case. In fact, let’s say the latest turmoil has generated that extra push for the dollar to break its range. That would suggest that the dollar’s momentum is panic-driven. In theory, once that panic dissipates investors should move away from the dollar.

However, since this isn’t the case, it suggests investors are judging the dollar by a different yardstick. They are identifying the dollar with the strength of the US economy and avoided panic buying.

And the bad news? If US data does indeed start to deteriorate, that would push the sell button. In that case, the dollar correction could be rather broad. In recent years, the US economy has tended to have a weak first quarter only to come back with a strong recovery later in the same year.

Although the US economy seems to be on a strong footing, the cyclical tendency for a weak first quarter could be misinterpreted. Some would believe the US economy was being dragged down. Subsequently, that could pull the dollar lower and the bear’s scenario could materialize, albeit perhaps temporarily.

We will learn a lot over the coming weeks and months. US economic data, as well as US retailers’ and banks’ earnings, will help us gauge which way we’re tilting. Until then, despite the flat performance, the dollar’s bullish bias holds.

Look for my post next week.

Best,
Lior Alkalay
INO.com Contributor - Forex

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.