Investors need to get ready for the domino effect resulting from a breakout in the U.S. dollar.
The U.S. Dollar index hit a 3-year high last week, up 7.5% in the past three months. That's inherently deflationary for emerging markets and commodities because a stronger dollar makes it that much more costly for foreigners to buy or service assets/debts priced in dollars.
In other words, look out for the following risky asset classes as we head deeper into this strong dollar environment...
- Emerging Markets have loaded up on an astonishing $9 trillion in US-dollar denominated debt.
- Commodities (i.e. oil and gold) are priced in dollars
It's worth noting, over the past 3 months:
- Emerging Markets index (EEM) is down -6.9%
- Gold (GLD) is -9.5%
- Oil prices are down -3.8%
As Hedgeye CEO Keith McCullough said on The Macro Show recently: “It’s the lead domino in the deflation of asset prices. The U.S. dollar breaking out from here is uber deflationary.”
A sustained dollar deflation risk isn't yet fully appreciated by Wall Street consensus, according to CFTC data on institutional futures and options positioning. The Chart of the Day below (from today's Early Look) shows the current positioning of institutional investors.
The Z-score below compares the existing net contracts (currently 48,278 for the U.S. Dollar) versus the 1-year and 3-year averages. Essentially, a reading above +2.0x indicates that investors are very bullish and -2.0x suggests they are very bearish. That's a contrarian indicator implying that a move, in either direction, is overdone.
We're not there yet. There may be more upside for U.S. dollar from here:
- US Dollar net LONG position of +48,278 contracts was DOWN -3,871 contracts week over week
- US Dollar net LONG position currently registers +1.55x and 0.66x on a 1 and 3 year z-score, respectively
That means more downside for Emerging Markets, Gold and Commodities from here.
