January 31, 2018

Currency Volatility

 We interrupt the white-hot arc of the stock market for this public-service announcement: Watch the dollar.

While any number of factors might be selected as reason for the DJIA’s 360-point drop yesterday, one macro factor correlates well: The relative buying power of the US dollar, the world’s reserve currency.

Give me two minutes, and I’ll show you.

Sure, one can say the market is due for a pullback. But randomly? Donald Trump’s first inaugural address is an easy target. Do we call investors schizophrenic if the market regains yesterday’s losses today or tomorrow?

How the US dollar fares versus other global currencies remains a barometer for US stocks. It’s been especially true since 2008 because the Financial Crisis marked a stark turn for central banks toward coordinated global policy.

But all the way back to 1971 when the United States left the gold standard for the 20th century’s version of a cryptocurrency experiment, a floating-rate dollar, shocks to equities trace to gyrations in the currency (the economy’s risk assets like stocks and bonds have replaced gold as the backing commodity but that’s another story).

Black Monday, the October 19, 1987 global stock crash that hacked 508 points or 23% of blue-chip value off the Dow Jones Industrial Average (DJIA) followed a stretch of currency volatility (and interest-rate volatility as the two are intertwined).

For perspective, the DJIA lost a greater number of points just now, Jan 29-30 (533), than it did Oct 19, 1987 (508). Heights today are so lofty that past ravines are wrinkles.

The collapse of the Internet Bubble in 2000 came after a sharp acceleration for the dollar on rate hikes by Fed chair Alan Greenspan to slow what he famously called “irrational exuberance.” He recognized the stock market reflected inflation, which as Milton Friedman said, is always and everywhere a monetary phenomenon.

Inflation is more money than an economy can readily deploy, not rising prices, which is a consequence. Stuffing money into economies is like squeezing a balloon. You don’t know where the air pockets will form.  Prices rise, but not always how or where central bankers suppose.

On May 6, 2010, market seams split fleetingly in the Flash Crash, the DJIA first plunging down and then bucking back up about a thousand points.  Before it, volatility was rattling the euro/dollar trade, a product of 2009’s massive “quantitative easing” by the Federal Reserve as the US central bank gave the global money balloon a giant squeeze and the dollar went into a steep dive.

In latter August 2015 the DJIA lost more than 6% over a series of days following a sudden currency-devaluation in China that tripped the delicate global balance.  And remember the Fed’s first post-crisis rate hike – a buck-booster – in Dec 2015? Near catastrophe for stocks (most for energies as oil plunged when the dollar rose) in January 2016.

We come to yesterday. What came before it? Last week the dollar plummeted about 3% as traders interpreted comments by US Treasury Secretary Steven Mnuchin to mean he wanted a weaker dollar.

Sure, there’s a sort of Clockmaker God quality to the idea that if we can pan back in the mind’s eye, the financial markets are all perched atop a giant dollar bill that occasionally flutters and spills something into the abyss.

On the other hand, it could be fixed. The dollar, that is. If the dollar wasn’t always fluctuating, we could better concentrate on, say, saving more, or investing capital without worrying about the corrosive effects on returns of a depreciating currency.

So, Jay Powell.  You’ll be steering the Fed after Janet Yellen bids us adieu this week. Imagine how much easier everything would be if the dollar wasn’t one of the things gyrating like stock-prices.

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