The US Dollar is KING as Yellen and Draghi Diverge
31st May 2016
Stay tuned and be prepared…We are approaching a historically key juncture in global markets as:
1. Brexit decision draws near on June 23rd and
2. Spain faces elections on June 26th
…And perhaps more importantly:
3. The FED wants to potentially shift gears! Indeed, the US is leaning towards a hike in June or July based upon recent Fed rhetoric…
Question: Is the Fed testing the markets’ ability to sustain a hike by sending up a trial balloon? If so…and if asset markets decline (read equity markets) then…will the FED decide NOT to hike?
Answer: I do not know. The FED is in a difficult situation. If it decided not to hike because of declining risk markets, it would signal that the FED is a hostage to the markets.
To Hike or Not to Hike…that is the Question
I have actually argued in previous writings that the FED should hike based upon US domestic conditions (rising core inflation and strong labour market). But global fragility dictates that the FED should exercise restraint.
Implications of a FED hike in June/July
1. Volatility should increase, setting off alarm bells at Hedge Funds via Value at Risk models…forcing a reduction in risk.
2. US Dollar will most probably rally (USD Index chart with arrow to 103)
3. Emerging Markets Bonds and Equities will probably fall as capital flows to the US Dollar
4. Credit spreads should widen
Did Quantitative Easing (QE) work…or did it fuel deflation?
Question: Have QE and ZIRP/NIRP (Zero and Negative Interest Rate Policy) worked?
Answer: The Velocity of money clearly says NO!
Source: Bloomberg, as of May 19th 2016
People are hoarding money despite a flood of liquidity having been unleashed by the FED and ECB. This is because they fear the future.
Perhaps a FED hike would actually encourage Americans to spend and borrow, as the age of Post- Quantitative Easing evolves into Quantitative Exhaustion …perhaps QE and ZIRP and negative interest rates fuel deflation!?
But the ECB will not even contemplate this, as it would be an admission of defeat…so the monetary policy divergence will continue…causing capital to flow to the USA and strengthen the US Dollar.
For fund distributors and professional investors only
FED: US Federal Reserve; QE: Quantitative Easing; ECB: European Central Bank
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