CATALYSTS FOR A CORRECTION

Conclusion: We at Hedgeye aren’t alone in our stance that the Fed’s Quantitative Guessing won’t end well. Several important countries and figureheads have joined in the anti-QE parade and we feel that this, combined with other factors is bullish for the U.S. Dollar – and bearish for [nearly] everything else.

Position: Long the U.S. Dollar (UUP); Short the S&P 500 (SPY); Short the Russell 2000 (IWM); Short Emerging Market Equities (FFDs);

On our Morning Macro Call (email if you are an institutional client and need a live dial-in code), Keith identified three catalysts that are potentially bullish for the U.S. dollar in the near term, which could potentially trigger a 6-9% compressed correction in U.S. equity markets. Those catalysts are: 

  1. Obama’s trip to Asia (starting now for the next ten days): Simply put, Asia is peeved with U.S. monetary policy. Central bankers from China, Japan, Hong Kong, Korea, and India are calling out U.S. monetary policy for what it is – “uncontrolled money printing” and pursuant of a weak dollar. Further, most of these nations are continuing to take measures to counter the inflation Bernanke’s printing press is creating in their countries. Obama will have to answer some tough questions and his rhetoric could prove dollar bullish if he attempts to pander to his Asian counterparts.
  2. October Global Inflation Data (now-month end): We’ve seen countries from China to India to Australia to Sweden raise rates in the last two weeks. Simply judging by the performance of the CRB Index during October, there is further tightening on the horizon. Global hiking could, on the margin, drag U.S. Treasury yields higher and the U.S. dollar with it. To some extent, we’re starting to see that occur on the long end of the curve (see chart below).
  3. G20 Summit in Seoul (Nov. 11-12): Tim Giethner might wind up playing a game of one-versus-nineteen on U.S. dollar policy. For a glimpse of what might come, see commentary out of Brazil’s Finance Minister Guido Mantega on the effectiveness of QE: “It doesn’t work to throw money from a helicopter because this won’t make growth flourish”. Germany’s Minister of Finance, Wolfgang Schauble said Thursday, "I don't think that the Americans are going to solve their problems with [QE2], and I believe that it is going to create extra problems for the world”. Timmy’s got some explaining to do come next Thursday. 

CATALYSTS FOR A CORRECTION - 1

On another note, it seems everyone is bearish on the U.S. dollar and bullish on commodities and global equities, including Franklin Templeton’s Mark Mobius. More signs that dollar bearishness are at its peak are: 

  • Belarus is going to become the first country outside Russia to issue debt in rubles to borrow at cheaper rates than U.S. dollars. Countries tend to want to borrow money in currencies they think are going to depreciate, so yields on dollar bonds have gotten too expensive for Belarus. The same is happening to Chinese companies, who are seeking cheaper dollar bond rates by borrowing in Hong Kong vs. mainland China.
  • RBC said the Argentine peso (per U.S. dollar) was the most “attractive currency in the universe they watch”.
  • Turn on CNBC and listen to pundit-after-pundit tell you how QE2 will crush the dollar. For their collective references, the U.S. dollar index is down roughly (-8%) since Bernanke tipped his hand in Jackson Hole, which is a substantial move for the U.S. dollar in a short period of time. 

Clearly, we were early and right calling the accelerated decline in the dollar starting this summer, but evidence is continuing to mount that a weak dollar is solidly consensus. President Obama and his cabinet will see mounting pressure over the next two weeks to adjust their policy towards the dollar as they travel abroad.  Longer term, it is not in their best interests to ignite a currency war, so we would expect their rhetoric to adjust accordingly and be supportive of a stronger dollar policy.

Have a great weekend,

Darius Dale

Analyst