An investor stares at their watchlist in disbelief. Quickly scrolling down, every asset is down, a sea of red flows from their monitor screen. It is September 2022 and global markets have been brutalized. Inflation continues to run hot as fed chairman Powell, like a broken record, screams the FED’s commitment to the dual mandate. Something does not add up – how can currency be inflating while assets bleed value?
Across the board assets and currencies are down. The Dollar Index (DXY) remains in a parabolic uptrend as interest rates hike and Quantitative Tightening (QT) put downside pressure on markets. The investor’s worst nightmare has become reality.
The question on everyone’s mind “where is the money going?”
DXY stands as the only contrarian, a massive green wall unscathed by the moves of other markets. This should be confusing to investors – CPI numbers in August came in above predicted 8.5%… how can the DXY continue to climb? This is best explained by examining the weighted basket that the DXY represents. “The euro is, by far, the largest component of the index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%), and CHF (3.6%) – Investopedia.com
Inflation is not unique to the US dollar in the current Forex climate. This is especially highlighted by the euro’s plummet below parity with the dollar, GBP’s recent descent to near parity, and simultaneous multi-year support being smashed on JPY, CAD, SEK, and CHF.
Perhaps the best way to understand what is happening is to imagine each of these currencies being dropped out of a plane, each with its own sized parachute. They all begin accelerating towards the ground at varying speeds, the dollar however brought the biggest chute and therefore is falling slower than its peers. Gravity will deliver them all to the ground eventually, the dollar (currently) is on course to be the last to touchdown.
The dollar is not gaining strength, it is dropping the slowest.
Major US Indices such as Nasdaq, S&P 500, and Dow Jones remain in perfect inverse correlation to the rising DXY. Each index seeing sell offs akin to the March 2020 crash. The extent of their sell offs was so bad, in response the US re-defined ‘recession’ to avoid further sentiment damage to investors. While individual stocks have seen scattered green days the market as a whole appears limp and unable to retain any gains. All eyes are fixed today as SPX plummets below June’s low, breaking down to levels not seen since 2020.
September has not been kind to precious metals. Gold has broken below a multi year support and is currently trading in the low 1600’s. Despite its claim to ‘store of value’ it appears to be following equities down with little hesitation. What was once considered a safe haven in uncertain economic times is now mirroring its physical properties, weak, malleable, and quick to bend under pressure. There are many explanations and excuses available – justifying its behavior. However for the sake of this article, we will acknowledge its seemingly irrational behavior and move on.
Bitcoin and the total cryptocurrency market has perhaps been the most savaged since November 2021, dropping 75%~ from 3 Trillion to 762 Billion. Currently it hovers just under 1 Billion. Trading in-sync with US equities, talk of correlation and risk-on asset behavior are buzzing. The highly criticized asset class, birthed in 2009 by anonymous creator Satoshi Nakamoto, designed in response to a similar currency crisis does not currently appear to be the safe haven for capital. However, unlike equities both Bitcoin and the total cryptocurrency market cap has to date held its lows set in June 2022. While this remains true, crypto investors hold onto hope that it will function as intended – as a hedge to inflation and monetary mismanagement. Time will tell if it is truly resilient in the environment it was created to thrive. At the moment, it has not been delivered.
If forex, equities, metals, and cryptocurrency are all in the same sinking ship where is the money going? The answer appears to be government backed bond yields, particularly US Treasury bonds. Earlier in 2022 the US experienced yield curve inversion for the first time in over a decade. US02Y yields overtook US10Y yields foreshadowing deep pain and economic decline. As investors’ risk appetite continues to dry, bond yields have laid claim to robust up trends. This is perhaps the only logical asset-market response in this article. But can this be our answer to the question – where is the money going?
In part, yes, I believe capital is seeking shelter in bonds. However, it does not appear to fully satisfy the query. Climbing yields are a problem of their own and largely a symptom of inflation.
Global markets fester with uncertainty. Investors are scrambling to find shelter from the storm and currently only finding minor protection in the US dollar & government backed bonds. It is logical that money is flowing into these assets, however I do not believe this fully represents where capital is moving. The answer I believe is an unsatisfying “We don’t know.” The FED appears to be dead set on tightening until something breaks. Perhaps after it is accomplished we will witness the strongest asset lay claim to the throne of capital.