The Markets Need to Quit Yellen by Chad Shoop, The Sovereign Investor.
My air-conditioning unit went out — just in time for the in-laws to arrive for a visit. If you live in Florida, then you know that last week was not an ideal time to lose AC.
I immediately jumped to the worst-case scenario: I have to buy a new AC unit.
Not an inexpensive proposition, as you know. But once I accepted this possible reality, I was able to move forward to diagnose and attempt to fix the problem without losing much sleep.
Dan Loeb's Third Point returned 11% in its flagship Offshore Fund and 13.2% in its Ultra Fund for the first quarter. For April, the Offshore Fund was up 1.7%, while the Ultra Fund gained 2.3%. The S&P 500 was up 6.2% for the first quarter, while the MSCI World Index gained 5%. Q1 2021 hedge Read More
Yet, after speaking to a relative who is an expert in AC units, he explained it was probably just a short in a wire. That turned out to be the case, and I fixed it without having to pay a dime.
Since I accepted the possible outcome of the worst-case scenario — that I would have to fork over thousands of dollars to replace my AC — it made any other outcome that much sweeter.
Which brings me to the Federal Reserve today…
What happens if the Fed raises interest rates? The worst case scenario is the recent strength in the U.S. dollar. That’s because as rates begin to rise in America, it is against a backdrop of falling rates around the world. As a result, our fundamentally weak dollar is suddenly in high demand — which is what we have seen in recent weeks even though the Fed hasn’t raised rates or even given a time frame yet.
And that’s where the opportunity comes in.
The markets are acting as if this worst-case scenario is a sure thing — hint: It’s not.
They are buying a brand new AC unit (worst-case scenario) but they haven’t done their due diligence into the dilemma at hand (just a temporary outage).
In the end, dollar bulls will realize there was no need to prepare for the worst-case scenario. Luckily for you, there is no need to wait for that exodus to take place. Now is the time to short the dollar.
Rate Hike Coming … in 2016 or Beyond
It is important to note that the excuse for the strong dollar today is due to expectations for the term “patience” to fall from the statement. That would signal that a rate hike is possible as early as the June 17 Fed meeting. If the Fed keeps the language, expectations will be pushed back to September, and we would see immediate-term weakness in the dollar.
This heightened expectation for a Fed rate hike comes as 24 nations already cut rates this year, with even more expected to follow suit — leaving the dollar as the only one left showing temporary strength.
It’s this dynamic that has caused the dollar to soar to its highest level against a basket of other currencies in more than a decade. The dollar has rallied more than 20% in the past year alone, a substantial move for any currency.
But, if you are following the Fed closely, you know that even if the Fed does indeed drop that “patience” from its statement, it is still leaning towards a later rate hike than June — possibly 2016 or beyond. You can’t forget that Janet Yellen is struggling to keep America from falling apart under more than $18.1 trillion in debt and higher interest rates certainly aren’t going to help.
A Dark Cloud for the U.S. Economy
The truth is that a strong dollar is bad, very bad, for the economic recovery and our unemployment rate.
With a strong dollar, our exports become more expensive — as fewer goods are being sold it leaves less jobs to be had here at home, and in turn, lowers our GDP growth.
It’s also coming at a time as commodity prices plummet. And it’s not just oil prices that are falling. In the past year, natural gas, gold, platinum, silver, copper, corn and wheat have dropped double-digit percentage points, leading to a decline in consumer and producer prices. Don’t forget that a higher dollar means our import prices are falling as well.
This downward pressure on inflation is something the Fed doesn’t want to see. The Fed doesn’t want to chance the possibility of propelling our economy into deflation by raising rates.
These two worries will be enough for the Fed to delay rate hikes. And with any potential rate hikes being pushed farther and farther into the future, the dollar is going to pull back.
Don’t Front Run the Fed, Front Run the Markets Instead
That’s why today is an ideal moment in time to short the dollar.
The dollar bulls are practically in euphoria. Everyone believes the dollar will go higher. Everyone knows the Fed will raise rates in June. And everyone believes this week will make higher rates that much more of a reality.
The only problem is that higher rates aren’t the reality.
The reality is that the Fed hasn’t raised rates. In fact, the Fed hasn’t even dropped “patience” from its language yet. Instead, Janet Yellen & Co. continue to preach an easy money policy will be around for longer than normal.
None of this has stopped markets from pricing in the expected rate hikes.
In short, markets are trying to front run the Fed — but it won’t happen. Instead, we have the opportunity to front run the markets.
Once investors come to the realization that their worst-case scenario (the Fed raising rates this summer and bolstering the dollar) isn’t coming to fruition for some time, there will be instant selling pressure in the fundamentally weak dollar.
Go ahead and grab the PowerShares DB U.S. Dollar Index Bearish ETF (NYSE Arca:UDN) before the market hits the sell button.
Dollar strength won’t last and this Wednesday’s FOMC meeting could be the tipping point.
Editor, Pure Income