A tectonic shift may have just occurred today, which went otherwise unnoticed by equities. While the bond market quietly whispered signals, the currency market sent a message that was loud and clear. The Dollar may have stopped going down today following the Fed meeting, and that could be bad for equities at some point in the future.
A strong dollar is bearish of US multinational companies, making products in foreign countries more expensive and less competitive. That means lower earnings, and lower earnings lead to multiple compression and falling stock prices. Something changed today.
The FOMC Meeting
The results of the FOMC meeting today appeared as dull as could be with the Fed passing on raising rates, which was no surprise. However, what did come as a surprise was the more hawkish tone the Fed took towards future rate hikes and the run off the Fed’s balance sheet. Not only was the news hawkish, but it was a total surprise to myself, as Janet Yellen’s term as FOMC chair expires in January, and Stanley Fischer the Vice Chair is resigning in Mid-October. Seems like an odd time to start implementing a new policy, especially since there is no sign of who may replace Yellen.
The reaction in the market was surely not noticeable on the Equity side with the S&P 500 finishing the day up only 1 point, closing at a new high of 2,508. It wasn’t all that noticeable on the long-end of the Treasury curve either with the Ten-Year Note rising by only four basis points to 2.27 percent. But it was very noticeable if you watched the Dollar vs. the Euro, Pound, and Yen.
The Euro’s Big Move Vs. The Dollar
If you aren’t familiar with movements in currencies rates, the Euro moved by over one handle, from 1.20 to 1.1880, which for the Euro mid-day is a pretty big move. Not only that but you can see in the chart below how the EUR/Dollar has failed now on three occasions vs. the Dollar at 1.20. That is a bearish signal, meaning the Dollar could set to strengthen vs. the Euro.
The Yen Set To Weaken
Additionally, the Yen appears to be getting set to weaken vs. the Dollar as noted in the next chart, as well.
The Spread You Need To Watch
When you look at the spread between the US10 Year Treasury and German 10’s you see can the spread of the US10 minus German 10’s has now started to widening again. If this should continue and begin to pick up in pace, it would indeed signal that the Dollar has bottomed and is set to start to rise significantly.
The Equity Market Impact
If this is indeed the case, and the market is viewing the Fed more hawkishly, then the days of the Dollar weakening are over, and it could be well back on its way towards the 100 level on the Dollar Index. This would be a massive headwind for Equity prices. Because now all those US multinationals that were getting the benefit of a weak Dollar, will now get hurt by a strengthening dollar, which would then pressure earnings, and then multiples, and stock prices
Be on notice, and watch over the next 24-48 hours, the spreads on the US10 and German 10, and the Dollar vs. Euro and Yen. Today could mark a tectonic shift.
Disclaimer : Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
Article by Michael Kramer, Mott Capital Management