US Dollar on its peek
In the past 2 years, the money supply has increased from $15.5 trillion to $21.8 trillion. This has caused asset valuations to go parabolic and inflation to go through the roof. We’re seeing CPI readings come in at over 8% and gas prices in some parts of the country have soared past $6 per gallon. Despite all these red flags, for the longest time, the Federal Reserve was insisting that inflation was simply transitory and that it was just a matter of time until prices stabilized. While the market was somewhat skeptical of this idea, it gave the Fed some credit until the Fed rug pulled everyone and became extremely hawkish. Ever since then, the stock market has gotten crushed with many mega-tech companies falling 50, 60, and 70% from their all-time highs. Meanwhile, the housing market is starting to show its first signs of weakness with new home sales dropping off substantially. Considering all this, you would expect the dollar to currently be performing a cliff dive maneuver, and this is what’s happening from a nominal perspective. However, from a relative perspective, the dollar is skyrocketing. Wait wait wait wait, what am I even talking about? Well, I’m talking about the dollar index or ticker symbol DXY. If you’re not familiar with the dollar index, it seeks to measure the strength of the US dollar relative to a basket of foreign currencies. And over the past 12 months, the DXY has mooned to multi-year highs. And if you want to get technical with it, you’ll see that the DXY has reached a slightly higher level than the peaks of the past several years. The last time the DXY was this higher than this way was back in December of 2002 or nearly 20 years ago. And if you don’t believe this index, then just take a look at foreign conversion rates.
The Euro, for example, has fallen to multi-year lows against the dollar, and it’s nearly at 1 dollar per euro. Similarly, the British pound is also testing multi-year lows against the dollar, and the last time the pound was sizeably weaker than this was way back in 1985. While the US dollar is getting crushed in terms of buying power, it’s gaining dominance over the world currencies, so what in the world is going on with the dollar?
SUPPLY & DEMAND:
Starting with the biggest culprit, we have supply and demand. Though we often like to think of currencies as a stable medium of exchange during regular times, currencies are subject to all of the same supply and demand characteristics that affect something like the stock market. Currencies simply have extremely low volatility during regular times. However, with groundbreaking events like printing trillions of dollars followed up by suddenly raising interest rates, it’s not surprising that even currencies are experiencing abnormally high volatility. Also, it’s not just the US that has been engaging in such activities either. Most of the world’s central banks have engaged in very similar monetary policies. Take the European Central Bank or the ECB for example. Since the pandemic started, they have also pumped trillions of dollars in euros into the market. Now, this isn’t quite as high as the US in terms of dollars, but the thing to note is that relative to economic metrics, the money printing of other central banks is just as high if not higher. For example, the total GDP of all the European Union countries that use the Euro is $12.23 trillion. While this is an extremely respectable figure, it’s only about 60% of the United State’s $20.94 trillion GDP. Now, this isn’t an exact science by any means, but this leads us to believe that the ECB cannot print more than 60% of the dollars printed by the US if they want to maintain the exchange rate between the two currencies. This same principle applies to smaller economies as well. The UK, for example, has a GDP of $2.7 trillion which is a little more than an eighth of the US. Given that the US has increased its money supply by about $6.3 trillion, this means that the UK could increase its money supply by about $800 billion. However, the UK has surpassed this threshold by quite a bit. So far, the UK has printed 895 billion pounds. If we use the average pound-to-dollar conversion rate in 2021 of 1.3757, we’ll see that this money printing correlates to $1.231 trillion which is over 50% higher than what they should’ve theoretically printed. If you look into the money printing of some of the other leading nations, you’ll see that they have fallen into the same trap of printing more money than the US on a relative basis.
On top of this, many of these countries aren’t pulling back nearly as aggressively as the US currently is. And for obvious reasons, this has led to the US dollar performing quite well in relation to these foreign currencies.
Aside from fundamental supply and demand factors, external fears have also influenced the dollar’s recent parabolic move. One of the top concerns for most investors right now is how hawkish the Fed will be over the next couple of months. Currently, there are rumors floating around that the Fed will hike rates by 0.75 basis points not once but twice in both June and July. Whether this ends up happening or not, the stock market has already preemptively corrected this. Some would even argue that it has overcorrected for this. Regardless of whether the market sell of is justified or not though, in the end, significant amounts of capital have left the stock market. By now, I’m sure most of you guys have seen already know how several companies have been shedding hundreds of billions of dollars in market cap. And while a lot of this value just evaporates away, the primary place the remaining capital is going is cash which is significantly driving up the demand for US dollars. Something else to note is that it’s only the stock market that has acted preemptively, the real estate market is yet to react. If the rumors regarding the Fed ended up coming true, the Fed would have raised interest rates by 2% within a matter of 6 months. Theoretically, home prices should drop 10% for every 1% interest rate go up. And given that home prices have just started to level off, this could mean that they have a rough 6 to 12 months ahead. And once again where does all the cash leaving the real estate market go, it goes to cash which further increases demand for the dollar in the short term. Also, it’s not just people pulling back on investments either. Some of the largest companies in the world will substantially pull back as well. Now, of course, Elon is out there buying Twitter, but he’s an anomaly. Instead, take a look at someone like Amazon. Amazon just posted its first quarterly loss in 7 years due to losses from Rivian, increasing supply chain costs, and slowing revenue growth.
Do you really think Amazon is going to go out and make big acquisitions anytime soon?
Probably not. The more likely scenario is that they’re going to hoard cash and prepare for a market downturn. Similarly, Apple is warning investors that sales could drop by as much as $8 billion within the coming months. Pair this with rumors that the iPhone 14 will be even more underwhelming than usual, and I don’t it’s very likely that Apple will be making any big moves anytime soon. And that’s just Apple and Amazon. I don’t even think I need to discuss the states of PayPal, Netflix, and Facebook. Now, none of this is to say that a market crash is even around the corner in the first place. After all, crashes don’t happen when everyone is expecting them. But, the key is that everyone from retail investors and small businesses to hedge funds and mega-cap companies is expecting it and consequently preparing for it. And all of this uncertainty is giving the US dollar significant buying pressure.
NO INFLATION HEDGING:
During times of high inflation, one of the first things investors do is move a significant portion of their wealth into inflation hedges. Historically, the most popular inflation hedge has been gold. For example, in the 1970s, when the US was experiencing double-digit inflation rates, the price of gold went vertical. Between 1976 and 1980, the price of gold went from $100 per ounce to $875 per ounce. Today, inflation is once again almost in double-digit territory; however, people haven’t really been flocking toward gold. In fact, gold hasn’t really moved since July 2020. Not to mention, it’s not like these are new levels for gold either. In fact, gold reached these same levels way back in 2011. If we take a look at silver, the story is even bleaker.
Between 1976 and 1980, silver grew over 10x from $3.80 per ounce to $48.34 per ounce. Today, however, like Gold, Silver hasn’t moved since July 2020. What makes silver even worse though is that it’s literally 50% lower today than it was at the peak of 1980. Of course, many Silver bulls would suggest that this is precisely why Silver is such a good investment and that it’s extremely undervalued currently. Now, they could be absolutely right and Silver may be on the cusp of a historic rally, but as of right now, Silver nor Gold has really done much meaning that very little cash has flowed into these inflation hedges. It’s not just historic inflation hedges that aren’t getting any love either.
The best example of this is Bitcoin.
Many Bitcoin bulls suggest that Bitcoin is the new gold and that it’s the perfect inflation hedge given that its supply is capped at 21 million coins. Ethereum bulls would argue that Ether is an even greater inflation hedge than Bitcoin given that Ether is actually headed towards becoming a deflationary cryptocurrency. Yet, despite all this, neither Bitcoin nor Ethereum is rallying substantially. In fact, they’re both down nearly 50%. Now, I gotta say, even though Bitcoin and Ethereum are by no means making new all-time highs, they’ve actually been holding up extremely well given that they’re down less than companies like Netflix and PayPal. With that being said though, we have yet to see any meaningful move towards inflation hedges meaning that all the money people are cashing out of the stock market and the bond market is just staying cash. And this is keeping demand for the dollar quite high.
STATE OF THE DOLLAR:
At the end of the day, the main takeaway from all of this is that despite all of the Fed’s quantitative easing, the dollar is actually still holding up extremely strong from a global perspective. Now, this has nothing to do with inflation or prices. After all, if the US has a 10% inflation rate while the rest of the world has a 15% inflation rate, the dollar would still be performing extremely well in relation. The main factors driving forward the dollar right now are enormous amounts of money printing from other countries, extreme uncertainty in the market regarding the fed, and very little inflation hedging taking place. Looking forward, whether this momentum will continue or not comes down to the Fed’s stance over the next couple of months and whether inflation starts to cool down substantially. If inflation cools down and the Fed backs off, then it’s very possible that we enter a risk on the market once again. And during the risk-on market, people don’t hold cash. Rather, they invest it all into assets that will drive down demand for the dollar. This could cause the DXY to stagnate or even start trending down. On the other hand, if inflation continues to get worse and the Fed becomes more hawkish, the market might become even more at risk of causing the dollar to reach levels that it hasn’t seen in decades, but we’ll just have to wait and see.
Do you guys think the DXY is going up or down?
Comment that down below.