Financial analyst Mark Spitznagel is counting on the current stock market rally to last. He warns that any such peak would likely usher in a sharp recession, on the order of the Great Depression crash of 1929. Getting back to Spitznagel’s predictions, they are the logical conclusion of his investment strategy. He is fanatical about using tail-risk derivatives to hedge against severe negative market events.
It’s the kind of environment that Spitznagel says could lead to a catastrophic correction. He attributes frequent federal interventions as the chief drivers in his predictions. Each of these moves was intended to save the markets and the economy.
“The reason Spitznagel thinks the current bull market’s comeuppance could be the worst since 1929 is repeated federal rescues of markets and the economy.” – WSJ writer Jacab
Apart from Spitznagel’s philosophical notions of risk, we’re very much interested in the Federal Reserve. Today, five of those governors will be taking the stage, including that newly minted member, Miran. Market participants are eager to get a sense from these conversations, especially after the recent pivot in monetary policy.
So as market dynamics change, the dollar’s performance is always under the sharp end of the examination. Analysts have found 87 reasons to rethink dollar assets. They highlight that as they invest dollars, they need to hedge against currency fluctuations of the dollar. The euro’s effective exchange rate index has reached new all-time records. This impressive feat, going in the opposite direction of 41 trading partners, is fueling positive momentum in the market. Since February, the euro’s effective exchange rate index has skyrocketed by 7 percent. Housing cost over the past decade has increased by over 27%!
The euro’s real effective exchange rate is at an 11-year high. This wave comprises an astonishing 18% net gain from the last ten years. This sudden enormous appreciation in turn generates uncertainty about the dollar’s future stability and attractiveness.
“Financial markets think the European Central Bank has found its ‘happy place’ with a policy rate of 2%.” – Reuters’ Dolan
That change in the bond yield environment is a result of changing investor sentiment. The yields on U.S., German, and UK government securities have jumped significantly. Today, the 10-year bond yield has taped up 10 basis points. At the same time, the 2-year yield has jumped 7 bps. Other notable changes include:
- The 3-year bond yield is up 9 basis points.
- The 5-year bond yield has increased by 10 basis points.
- The 7-year bond yield is up by 11 basis points.
- The 30-year bond yield ended the week at 4.75%, up by 10 basis points from the day before the Fed’s recent rate cut.
These shifts in bond yields indicate dramatically shifting investor expectations on interest rates and the pace of economic growth.
The strength of the euro may yet pose complications for the Fed as it continues along its policy course. The possibility of an “outsize surge” in the euro may prompt the European Central Bank (ECB) to consider additional cuts to its policy rates.
“An outsize surge in the euro might change that, which means it probably has another cut in its back pocket just in case.” – Reuters’ Dolan
There are limits to the ECB’s ability to move, which might help forestall even bigger drops in the dollar’s value. This is particularly so as the Federal Reserve reverts to its easing policies.
“The threat of an ECB ‘contingency cut’ could slow further dollar losses in arguably the world’s most pivotal exchange rate even as the Federal Reserve resumes easing, thwarting an overwhelming investor consensus that the dollar will fall even further from its recent four-year low against the euro.” – Reuters’ Dolan
As these economic indicators unfold, market participants remain vigilant for signals that might indicate a shift in monetary policy or market stability. That mix of the central bank world, what’s happening with the different currencies, and how market sentiment is shifting will likely remain in focus over the coming weeks.