Andy Krieger's Thoughts on the Market - 7 March 2023

A month ago, I told my readers that we were embarking on a period of significant U.S. dollar strength. Since then, the dollar has strengthened against all major currencies, with the dollar posting its largest gains against the Australian dollar (the “Aussie”). The Aussie has depreciated by over 5% against the dollar, but there is still more weakness to come. I am not sure whether this phase of dollar strength will simply be a technical correction of the dollar’s major sell-off since September, or whether it will turn into something even bigger.

In my write-up in early February, I had noted that interest rates were poised to rise much higher than most people expected, but I expected the move to take longer than one month. In the past month, the yield on U.S. 2-year paper has shot up by over 14%, and this move seems to still have the power to carry on further. In response to the sharp rise in interest rates, many foreign investors have bought dollars so that they could enjoy the higher yields now available in U.S. treasuries, and they are likely to continue shifting capital into the U.S. as long as yields hold their current levels or go even higher.

Just as the dollar’s fundamental underpinnings are supporting fresh dollar buying, we are also now seeing early signs of medium-term technical buying. Some of this buying has been stop-loss driven as the dollar’s down trend from the winter months has reversed sufficiently to force many holders of short dollar positions to cut their positions. The balance of the technical buying is coming from fresh buying as a variety of time, price, and momentum indicators are starting to generate medium-term buy signals. Based on my own technical models, I expect this medium-term technical buying to accelerate if the dollar’s strength continues for several more weeks.

There are a lot of important economic data coming out over the next week, so the markets could prove to be particularly volatile. With forex and other speculative markets, it is easy to forget just how far and how long trends can persist. By way of example, the current levels of interest rates may have seemed unimaginable to many investors just eighteen months ago when two-year paper was yielding less than twenty five basis points, so it is important that we keep an open mind as to how far markets can go once significant trends get underway.

The recent moves in the stock markets have been particularly interesting, as investors are definitely fixated on the glass being half-full mentality. The logic driving the market action seems to work as follows: fresh strong economic data (from employment and economic growth) will drive the market higher as fundamentals are strong and demand remains robust. Alternatively, if economic data weakens, then the Fed will cut rates aggressively, supporting the equity markets with a de facto put option. Heads I win, Tails I win. What can be better than a one-way bet that can’t lose?

The reality is that corporate earnings have softened, and they will continue to soften. At some point I expect investors to wake up to the reality that one-way bets are fantasies. It is only a matter of time before we see a major sell-off in the stock markets, although we may see a short-lived rally first. My expectation is that the market will start to behave with an “up the stairs and down the elevator” sort of dynamic. Rallies will be more grinding, plodding advances, while sell-offs will be more violent, vicious declines. My hunch is that once we embark on a sharp “down the elevator” decline, we will finally see the yen start to appreciate dramatically. The yen tends to do well in risk-off scenarios, and it is only a matter of time before we see some major risk-off market conditions.

‍