The U.S. Dollar index, an indicator that measures the strength of the greenback against a basket of foreign currencies, has gone up 25-percent since July of last year, easily making it one of 2014’s hottest stories. Typically, currency traders transact their business in “pips,” or leveraged increments of unit based change. So small are the actual currency rate changes that using such a basis would not produce the magnitude necessary to make a trade financially viable. Thus, the 25% jump in the dollar might as well be a 200% lift in a stodgy blue-chip stock. However, the stunning turnaround that was Federal Reserve Chair Janet Yellen’s announcement, in which anticipated interest rate hikes was put off until after April’s Federal Open Market Committee, has put a monkey wrench in the dollar bull’s joy ride. The resulting slip in the dollar index, which just recently closed above the 100 mark, has many experts pondering the fate of the world’s reserve currency.
As the greenback was charging its way into the heavens, European Central Bank president Mario Draghi offered a mirrored reality. His aggressively accommodating monetary policy, a strategy similar in magnitude to actions committed by the Fed and the Bank of Japan, was aimed at sparking economic momentum. That the Euro currency was going to collapse was a given, and a much needed one: a weaker currency provides a significant advantage towards exporting companies. In fact, many business media figures such as Maria Bartiromo half-joked that now would be an ideal time to take a European vacation. Good advice, especially if you were already considering the journey. But as technical indicators suggest, that window of opportunity may be closing fast.
The reluctance of the Dow Jones Industrial Average to build off its all-time record valuation is a troubling harbinger for dollar bulls and discount vacationeers. Similar to the greenback, the Dow has been the darling of global investors over the past two years, producing respectable annual returns and coming back strongly from moments of volatility. But since peaking at 18,053 points a few days before New Year’s Eve of 2014, the market has only returned 0.4%, a paltry performance given what investors have come to expect. The violent and erratic “seesaw effect” over the past three months also suggest that long-term investor confidence is waning.
Who Will Buy?
As a market psychology rule of thumb, the intensity of trading is always greater on the downside than it is to the upside. This is due to the panic effect, where unsteady and nervous traders or fund managers quickly hit the sell button in order to protect their vast portfolios. Such an action cascades to the retailer investors (the general public), who take their cues from the big boys. The amount of steep selloffs witnessed recently in the Dow confirm that the institutional players are not buying Yellen’s and the government’s feel-good story regarding economic recovery. And if such powerful entities aren’t buying it, who will?
Should the Dow correct significantly, which it appears apt to do, more pressure to keep the gravy train running will be applied to the Fed and other policymakers. The best weapon that the Fed has in this scenario is to inflate. With the dollar index unusually high given the real fundamentals of the economy, an accommodative policy would in theory have a less jarring effect than it did when Yellen’s predecessor first applied it. Essentially, the Fed has been gifted a free lunch, courtesy of your next European trip.