Stock market volatility has no doubt been top of mind this week for our readers and viewers. Analysts seem to have been working overtime trying to find explanations for the stock sell offs this week amid higher U.S. Treasury yields.
Although it has not been in the headlines, there has been some momentous news in foreign exchange this week as well.
As we've talked about recently, the U.S. dollar has been dropping dramatically over the last couple of months. But this week, the dollar actually gained about 1 percent against most other major currencies, with the only exception being the Japanese yen.
Why has the dollar rallied? I see three possible reasons:
- Declining momentum has been depleted. The dollar has fallen by just under 6 percent since the middle of December. Just as the stock market can't climb forever, the dollar couldn't keep falling indefinitely.
- Short positions on the dollar are stretched. The International Monetary Market weekly position report of speculative FX trading on the Chicago Mercantile Exchange shows that short dollar positions as the end of last week were at their highest level since October 2017.
- Oil prices have come down from their highs, and as we have mentioned before, the inverse relationship between oil and the dollar is very strong right now.
There is a possible fourth reason that is often disputed in FX circles: Is the dollar still functioning as a safe haven currency? Traditionally, traders talk about gold, the Swiss franc and - in recent years - the Japanese yen as currencies to run to when volatility returns.
There certainly is precedent for this. In the wake of the 2008 credit crisis, the dollar strengthened by 7 percent as U.S. investors fled foreign assets to focus on liquidity back home.
But these days we are experiencing alternating periods of market optimism punctuated by bouts of sudden volatility when something goes awry in the financial or geopolitical world.
My View: The safe haven theory makes sense to me, for now. Even with all the controversy in politics and the administration these days, markets look at the bigger picture. In the long term, I think it is likely that both the dollar and the stock market will settle down into a more predictable pattern.
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