King dollar is no friend of the bull market

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Since Bob Hoye from issued a sequential sell signal to listeners of his evening February 22nd broadcast, the S&P 500 has fallen 1.9%. In this week's broadcast he characterizes the late December sell-off as having "changed a lot of the magic in the markets", but suggests it is still not known whether the recent decline of the past two weeks will head to new lows.


Hoye: A rising US dollar is not a friend of the market

In that regard, the strength of the US dollar has the market historian concerned.

In terms of current conditions, Hoye is watching for a turn down in Treasury Bill yields, noting that such a reversal has already happened with LIBOR (London Inter Bank Offer Rate):

LIBOR is falling (click for larger)

The 3-month reached its high in the middle of December and it is actually heading down now...that says that at least in Europe and London, perhaps the contraction has actually started.

According to Hoye, one of the hallmarks of market peaks is cheerleading by Wall Street pros in the media who say don't worry and stay long because the Fed has perfect wisdom and will cut rates at the right time to keep the boom going. He notes that advice did not work in 2007.

You ended up in the worst financial calamity since the 1930s and interest rates came down. You've got people in Wall Street in high places with a theory that doesn't match with reality. Their theory is that in a crazy boom all the Fed has to do is lower interest rates and the boom will keep going. But in history, and there is 300 years of it, the reality is that short-dated rates, such as Treasury Bills, go up in the boom and down in the bust. They have cause and effect completely screwed up.

Lately, Hoye says he has not seen as many statements saying the Fed will prevent bad things. But, 5 or 6 weeks ago the buzz went through the market that there would be no more rate increases and then that is what helped push the latest rally which became quite impetuous.

We ended up with the notion all is all right because the Fed is going to lower interest rates

However, Hoye suggests if the stock market decline continues, the Treasury Bill rate is going to go to zero again and it will be just another example of the central bankers being behind the markets.

In terms of the US dollar, he notes historically in past financial bubbles the senior currency has gone down, but in every case once the bubble was over the senior currency went up. Right now, the senior currency is still the US dollar. His outlook is for general greenback strength.

The dollar will become chronically firm against most other currencies and most commodities for most of the time.

Hoye suggests this week's rise in the US dollar as the markets have become nervous is appropriate action. He expects it will be futile for policy makers to try and depreciate the greenback.

Once you get into a contraction, the Fed may wish to depreciate the currency, but it can't.

The problem the Fed faces with the dollar is the need for offshore debtors having to repay loans in US dollars. He seems worried that such a dynamic may already be at work. He describes dollar action thus far:

It reached a high in December as the financial pressures were maxing out, had a correction in here, but now it's at new highs, so it is back on the uptrend. It is not a friend of the market,

Hoye says we will have to see how this all works out. In terms of stocks, will this be a correction in a much longer rally, or has this been a rebound in a bear market? That will take some time to determine.

We agree. It will be interesting to see if flows back into US dollars needed to pay off private sector and foreign government debts outweigh possible concerns about the growing US budget deficit which is already $102 billion bigger than last year in the first 5 months of the year according to Congressional Budget Office (CBO) time-adjusted estimates. That works out to about a 23% jump by our estimates. We would also point out that CBO estimates assume 2.3% real GDP growth this year. So far, that assumption is off to a shaky start with the Atlanta Fed only expecting Q1 growth of 0.5% as of March 8th.

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