When equities sold off in March the risk-off mode also took down gold and strengthened the US dollar. It was clear that investors were not positioned for such a downturn as they were forced to liquidate positions. Most recently however this correlation between equities and assets has broken down. As equities fell toward the end of last week, gold and the Euro hit new highs.
I am looking for this move to continue. With the upcoming US election and the Federal Reserve being the underwriter for the global economy I see a potential significant liquidation in the US dollar. For that to happen, there needs to be an alternative. Clearly, there is a necessity to hold and transact in US dollars for vast swathes of the global economy, but there are also significant volumes, enough to move the market, which hold US dollars as a core holding which could move into the Euro.
The Euro has risks, not least of all a reversal in the recent coming together amongst the hardliners to fund grants and loans to the Southern nations. The breakdown of the Euro has however to some extent been priced in since 2009. There is less risk priced into the US dollar vis a vis social disorder and a resulting 'flight from quality'. Trump, whilst a divisive figure, has been pro-business. In an economy supported by the Fed lowering rates and expanding the dollar money supply, this is complementary to a rising stock market.
However, in the next 6 months with Biden ahead in the polls, the economic cost of COVID rising, social tensions exploding in many US cities, this formula leads me to believe Trump will take greater and greater risks. I believe he will continue to show a strong fist when it comes not just to dealing with protestors but also the Fed and his Republican party. Thinking forward to a potential worse-case under each of these scenarios gives a very negative US investment opportunity. The US dollar is simply not priced for the probability of these outcomes.
The stock market normally rises into US elections as the incumbent does everything they can to win the election. The ability of the Fed to ramp up printing and the potential for helicopter money is too strong to short equities in anything other than the SBY long-term strategy. A short US dollar trade however is much more compelling for exactly the same reasons.
I expect we will continue to see 'extend and pretend' until inflation is ignited through permanent social handouts. This seems some way away.