The dollar is whispering to investors, so listen up

As the dollar breaks parity with the euro, echoes of “is the euro a buy here” seem to be echoing in the trading rooms.

Apart from taking a psychological step, parity really makes no sense if you put it back into its financial and economic context. To put it simply, the Fed is in an interest rate tightening cycle given the difference between its federal funds rate and estimated consumer price inflation. The European Central Bank, struggling with even worse inflation, hasn’t really raised interest rates yet and continues to offer some monetary easing, despite the worrisome inflation outlook. This difference in interest rate differentials is what really drives the dollar versus the euro at the moment, as well as the safe haven status of the dollar, but it’s never really that simple.

There is no doubt that the global economy is going through a recession. US Democrats can try as hard as they want to redefine it, misleading the public that they are in a “technical” recession, but the numbers speak for themselves. After the Covid-induced stimulus spurt, prices for goods and services rose in a short time, creating inflationary shocks in a constrained supply system, but demand is now cooling.

Consumers are being hit across the board by rising mortgage costs, falling wage income growth and a high and rising cost of living, given soaring gas and electricity prices this year . European reference gas Dutch natural gas futures TTF prices are trading north of 270 euros per megawatt hour against less than 100 euros/Mwh at the start of the year. One-year forward electricity prices in Germany are trading at nearly 600 euros/Mwh. Gas prices in the United States usually average between $2 and $4/MMBtu, or Metric Million British Thermal Unit, but this year they have reached $10/MMBtu. Even US consumers have no respite as they face the highest electricity prices in decades. With the consumer unable to spend, this has dramatic implications for the gross domestic product of both economies going forward.

Another worrying development is the dollar against the Chinese yuan. This morning we saw the Chinese CSI300 index move below its short-term trendline. This is despite the small rounds of stimulus China has recently rolled out to support its housing sector. It’s seeing a weaker yuan against a rising dollar. We believe that these measures taken by China are a futile attempt to support real estate prices/markets, they are not accelerating or developing in any way. At the bottom of it all, China’s domestic demand is very worrying judging by heat waves, blackouts and blackouts all of which have negative implications for their GDP target for this year. China is exposed to Europe via Germany, so any hiccups in domestic demand will not help a struggling Chinese economy.

The next catalyst for the market is the Jackson Hole meeting at the end of the month where Fed Chairman Jerome Powell will be presiding as the market eagerly waits to hear if there is a change in the hawkish stance of the Fed. Fed. Judging by the evolution of the components of the consumer price index, it does not seem likely that the Fed will reverse its tightening position. A 50 basis point rate hike is almost a certainty, but the market is wondering if the Fed will be aggressive enough to raise interest rates by 75 basis points. The dollar continues to make new highs, especially against the euro. The euro’s 5-year forward inflation measures are higher, but the ECB is unable to do anything about it, given stretched balance sheets and huge piles of debt. The dollar may be overbought against the euro, this relationship is determined by the trajectory of dollar interest rates more than the fate of Europe.

If the Fed pivots, we could see a massive dollar collapse, but that pivot seems much further away. Unless, of course, the system crashes like it did in 2019…

Let’s look at the euro, dollar and yuan and see what a pivot from the Fed could do for the dollar. Liquidity, which has been the main driver of the market for the past decade, is also being withdrawn at a faster rate, with the Fed expected to double the pace of quantitative tightening in September to $95 billion a month, compared to the quantitative peak. downturn of $120 billion a month. But that free money has come to an end. It remains to be seen when the Fed will blink to bring back the punch bowl, but sadly, this “put” strike is dropping every day that inflation rises.

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