Parking In the Dollar Lot

The US dollar has strengthened recently, back to levels last seen in mid January 2018. Part of this move feels like a short squeeze, as selling dollars has been a fairly consensus trade this year. The balance, however, does have the ring of fundamental truth about it. US Treasury yields have increased more this year than their counterparts in Germany or Japan. And on a nominal basis, a 10-Year Treasury yield of 3.0% looks a lot more appealing than 0.6% 10 Year German Bunds or 0.05% Japanese paper.

Now, currency traders are no different from their counterparts sitting on equity and fixed income desks: any unexpected move means, “Someone knows something I don’t”. But what? Two ideas:

• The Fed is more hawkish than we think. There’s some good support for this thesis in the prices of Fed Funds Futures. Those now put the odds of 3 more rate hikes in 2018 at 39%, up from 29% a month ago. Wall Street consensus still hovers around just 2 increases.

• Global investors are reducing risk and parking capital in dollar assets. The dollar is, first and foremost, a safe haven currency. A sudden move higher is an unwelcomed signal that fear (about something, anything…) is on the rise. Yes, the Japanese yen often plays the parking lot role and it has been weakening since late March versus the dollar. But that is not enough to dismiss the rise in the greenback and what signal it may be giving.

The effects of the stronger dollar are filtering through to US stocks. Consider the following:

• Large cap Tech stocks are the only S&P 500 group where more than 50% of revenues come from non-dollar sources. That makes the sector uniquely exposed to a stronger greenback. For this (and other reasons, of course), Tech has underperformed the S&P over the last month (+1.9% vs. 0.8%). It also fared poorly during today’s decline (-1.7% vs. 1.3% for the S&P).

• Small cap companies have less international exposure than the S&P 500. The S&P Small Cap 600 is up 3.8% over the last month and the Russell 2000 is 2.9% higher. Both also outperformed the S&P 500 during today’s selloff.

Some further context, and our bottom line: realize that the dollar is actually still weaker YTD, and capital markets are responding to its breaking out of a tight range that dates back to only mid-January. This is not a breakout to new 2018 highs (that’s 2% higher) or even one-year highs (10% higher). The move bears watching, but feels to us more like a technical move rather than a fundamentally bearish catalyst for US stocks.