President Donald Trump gave a warning to stock traders. He has stated that in this trade war, there are moves being made which will have a negative impact on the stock market. He said that it’s not just about trade with China, it’s about trade with everyone. You are about to have inside information on what I think the President means in his warning to stock traders and investors.
The rich and powerful have already started pulling money out of stocks and going into defensive bonds, and the size of the move is staggering.
For the period from January 1, 2018 to April 8, 2018, Treasury bond funds had inflows of more than $9 billion. Compare that with equity outflows of more than -$28 billion!
This is a huge, defensive move out of stocks and into Treasury bonds.
This outflow of money from U.S. equities began in February, long before the escalation of the trade war with China. Something sinister is going on beneath the surface that has little to do with a trade war, and everything to do with the U.S. dollar.
In 2017, the U.S. was winning in the never-ending currency wars.
In 2017, the U.S. devalued its currency 10% to the yuan, 15% to the euro, and about 12% to the rest of the world.
The U.S. dollar was down -10% in 2017, which pushed the S&P 500 up more than 21%.
In 2018, we’re starting to see that trend reverse as the U.S. dollar bottoms.
Notice that the U.S. dollar began chopping out and going sideways right when the S&P 500 started going down. Notice the triple bottom test that suggests that the dollar has bottomed. In other words, the dollar going sideways is enough to cause the S&P 500 to sell-off. Imagine the carnage that would ensue if the dollar were to rise in value!
The Trump Administration had a huge tailwind last year based on dollar depreciation but now that’s been taken away.
The U.S. economy and the global economy was predicated on the fall of the dollar continuing. Even if the dollar chops out sideways in here, it has taken away that falling dollar tailwind.
China has taken action to push the U.S. dollar up by decreasing the global demand for U.S. dollars. China did this by establishing the petroyuan. The volume of petroyuan oil futures is comparable to that of Brent Crude oil futures priced in U.S. dollars.
The petrodollar is backed by Treasuries, so it can help support U.S. deficit spending on maintaining a global military presence. Take that away, and the U.S. can’t spend as much on Defense and the Chinese know it.
What gave China the power to topple demand for U.S. dollars was offshoring and outsourcing of U.S. jobs. China gained millions of jobs at the expense of the U.S. manufacturing sector. This allowed China’s economy to grow bigger than the U.S. and to become the largest consumer of imported crude oil.
Once China became the world’s leading consumer of oil, it allowed Beijing to exert its will over Saudi Arabia to pay for crude in yuans.
Now the conventional wisdom is that the petroyuan will hurt the value of the U.S. dollar, but I’m not so sure that’s true. The logic is that the dollar’s value depends on its use as an oil trade vehicle. When that goes away, we will likely see a strong and steady decline in the dollar’s value.
That’s looking at the value of the U.S. dollar from a demand side. However, look at what happens on the supply side in the supply and demand chart I created below.
If the demand for U.S. dollars goes down because central banks will no longer need as large dollar reserves to buy oil, the U.S. will supply less dollars and the global supply of U.S. dollars will fall (this explains why the Libor-OIS spread is widening but more on that later). This will shift the supply curve inward and a new equilibrium of dollar value will be established at point B.
Notice also that the unprecedented increase in volatility that led Jack Bogle to say that he hasn’t seen a market this volatile in his 66 years of being a trader, it too can be tied to the U.S. dollar.
Notice that when the U.S. dollar stopped going down, massive volatility hit markets:
Folks, the biggest story this year that’s not being talked about in the mainstream financial media is how the U.S. dollar has started to form a bottom, and it’s actually up a little bit from its January low.
A bottoming U.S. dollar is probably one of the biggest threats to the global economy.
Are central banks really maintaining this so-called synchronized growth? Or is everything not synchronized at all. What if the big move into bonds in 2018 are institutional investors coming to the realization that synchronized growth is a bunch of nonsense and that what we have so far in the Trump Administration is actually coincidental growth from a weaker dollar?
All of this global growth was predicated on the dollar continuing to weaken. If we are forming a bottom right now as the dollar chart suggests, then that’s a huge threat to the global economy and global capital markets. This explains why the bond buying began in February, before the escalation of a trade war with China. Bond inflows, and equity outflows, began when the U.S. dollar started forming a bottom.
Take a look at how the Libor-OIS spread is widening:
The Libor-OIS spread provides a picture of how the market is viewing credit conditions because it strips out the effects of interest-rate hikes, inflation, and growth expectations.
The Libor-OIS spread shows that short-term borrowing costs in the U.S. have risen to levels not seen since 2008 and the financial crisis! The Libor-OIS spread is the measure of how much it costs banks to borrow, as shown by Libor, relative to a risk-free rate, the kind that’s paid by highly rated sovereign borrowers such as China or the U.S. government.
This increase in the Libor-OIS spread is being caused by a dollar liquidity problem.
As the supply of U.S. dollars drops, thanks in part to the petroyuan, and as the Fed hikes rates, it’s causing the dollar to stop going down which means financing in dollars is becoming more expensive.
This growing dollar liquidity problem is causing the Libor-OIS spread to widen.
In other words, the fact that the U.S. dollar is bottoming is a major threat to capital markets.
The dollar has also stopped going down because of its relative value to other currencies and in particular the euro. Check out the performance last week of the US dollar to the euro:
The performance of the U.S. dollar is a mirror image to that of the euro. A weakening euro is adding to the strength of the U.S. dollar.
The ECB is in a much bigger hole than the Federal Reserve is in. The ECB has more than $5.5 trillion on its balance sheet. The Federal Reserve has about $4.4 trilllion.
The ECB and Draghi are playing the game of virtue signaling where they are constantly pitching the virtue of buying up assets across the EU and increasing the ECB’s balance sheet while promising that they are going to start buying less assets because of the great economic improvement across the EU. This is the same thing that Ben Bernanke did. All central bank heads do this to manipulate investors and the public. Psychologists call it virtue signaling.
When market participants realize that Draghi can’t cut back on QE yet, that’s when the U.S. dollar is really going to start to strengthen. In fact, the bottoming U.S. dollar already suggests that more and more institutional investors are questioning how truthful Draghi is really being about the health of economies across the EU, and if the ECB can really start to taper off QE.
The biggest threat to the global economy right now is not the trade war with China, but the fact that the U.S. dollar is bottoming.
Notice that the Twiggs Money Flow on UUP perfectly matches the moves on the S&P 500. When the Twiggs Money Flow goes positive, the market sells off. When the Twiggs Money goes negative, the market rallies. Also, notice how the large players volume spiked up at the end of January, right before the market correction in early February.
Don’t get blindsided. You need to watch out for a rising U.S. dollar.