U.S. Dollar in the Dog House as Death of the Bond Market Fuels Stock Market Rally 

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The Dollar was down for the count already Thursday but a steady death of the bond market could see investors bailing on the buck in earnest later this year, which would be a boon for Sterling and many other currencies if the summer's choc-a-bloc schedule of risk cannot bring it back to life in a meaningful way. 

The Dollar was down against all but the Swiss Franc and Canadian Loonie in the major currency sphere ahead of the North American open but is tipped by some to find support, if not recover in weeks and months ahead.

Price action came as bond yields fell while stock markets crept higher, extending a nascent rally that would have seen them all-but erase the coronavirus from history if not for charting technology and the virus' still-growing human cost.

"Investors are being forced to decide whether to jump on the risk-on bandwagon to avoid being left behind, or whether to retain a cautious tone ahead of an inevitable onslaught of bad economic data and a potential worsening of trade tensions between the US and China," says Jane Foley, a senior FX strategist at Rabobank. "The latter will be instrumental in containing risk appetite in the months leading up to the US election and potentially beyond."

Falling bond yields have historically been the result of investor unease over events in domestic or global economies, but were almost always incongruous with rising stocks and a falling Dollar until the advent of quantitative easing (QE) programmes that have crushed bond yields in perpetuity while seeing the world's top central banks become their governments top creditors.

Above: Dollar Index shown at daily intervals alongside S&P 500 stock index (black line).

Many analysts have made an even greater number of very plausible arguments about why stock markets should probably be cooling their heels and the Dollar holding its own right now, which would be an inhospitable environment for the Pound and other 'risk' currencies, but the Dollar's strength has continued to ebb even as the U.S. and China inch toward another confrontation and one which might this time have public support that transcends partisan lines.  

"Even before the coronavirus crisis poor US/China relations had had an impact in supporting the value of the USD. US/China tensions are again set to be a major market influence this year," Foley says. "The Trump Administration would not take kindly to any sharp increase in the value of USD/CNY. In view of the geopolitical risks, we view it as too early to expect a significant decline in the value of the USD in the coming months."

A joint statement released on Thursday by four of the 'Five Eyes' alliance including the U.S., UK, Australia and Canada underlines the pace at which the China problem could quickly become a banana skin that upends the nascent pecking order of performance. There were four signatories Thursday after two agreed Wednesday that "the international community must support the people of Hong Kong," and that list could grow larger still given the pace at which the world's second largest economy is tearing up the one-country-two-systems settlement on Hong Kong. China's legislative machine passed a controversial security bill Thursday that inserts its authoritarian and oppressive apparatus directly into the city and is increasingly aggressive in its bid to dodge scrutiny and accountability over the origins and initial handling of the coronavirus.

"Hong Kong has flourished as a bastion of freedom. The international community has a significant and long-standing stake in Hong Kong’s prosperity and stability. Direct imposition of national security legislation on Hong Kong by the Beijing authorities, rather than through Hong Kong’s own institutions as provided for under Article 23 of the Basic Law, would curtail the Hong Kong people’s liberties, and in doing so, dramatically erode Hong Kong’s autonomy and the system that made it so prosperous. China’s decision to impose a new national security law on Hong Kong lies in direct conflict with its international obligations under the principles of the legally-binding, UN-registered Sino-British Joint Declaration," the statement says, in part.

Above: Pound-to-Dollar rate shown at daily intervals alongside S&P 500 stock index (black line).

U.S.-China tensions, Brexit and other events elsewhere could yet engender even greater weakness into non-Dollar currencies through the summer months but nascent price action across markets could be an early warning of what might be just around the corner if this summer's toxic cocktail of risk cannot bring the buck back to life in a convincing, confidence-inspiring way. 

This is because central banks have all but killed the bond 'market' by reducing it to little more than a place where captive and manacled 'investors' go to pay the net opportunity cost extorted from them by legacy institutional investment mandates. In the process they have and still are raising the risk premium paid to all of the investors who have piled into the stock markets which have risen and still were rising sharply off March coronavirus-crisis lows on Thursday. 

This risk premium is an already-higher and still-rising reward being paid to multi-asset investors who've remained sufficiently compos mentis to see the writing on the wall for the 'risk free' rates paid to prisoners of the bond 'market' mug's game. Risk-free rates which might all really be no such thing at all. 

Above: AUD/USD shown at daily intervals alongside S&P 500 stock index (black line).

That's the legacy of QE adrenaline pneumatically hosed into bond 'markets' and onto fires of crisis. So much so those 'markets' are now little more than mechanisms of monetisation (true money printing), among other things and for the time being at least. The Deutsche Bundesbank view of the risks posed by quantitative easing is a good place to start for readers who're less familiar with what so-called money printing can mean for macroeconomic variables like inflation, which is a hoodlum that further extorts anything and everything left in the kitties of the manacled captives in the bond market mug's game.

However, the hoodlum is barely even able to get through the front door of the stock market. Stocks of large companies that have pricing power in their markets might be best able to protect capital from the potential adverse consequences of synchronous global monetisation among the largest of central banks. They underwrite economies accounting for what many would say is a shamefully large share of global GDP and the world would doubtless be a very different place if value-creators stopped getting out of bed, so if equilibrium-hunting investors are going to favour any asset at all it must likely be the shares of the biggest of the best companies as well as the most innovative of the small. 

Above: NZD/USD shown at daily intervals alongside S&P 500 stock index (black line).

Metaphorically, corporate powerhouses are effectively the mafia dons who can bully the central bank caporegime or capodecina and at the same time as they keep the inflationary hoodlum from the front door. This is not to suggest a dystopian future is in any way written into stone or even likely, but to illustrate the mechanics playing a significant role in price action across financial markets, in addition to all of the other interconnected drivers of ongoing moves. 

The currency market price action that results from this is a rub for the Dollar and can be a boon for others including a Brexit-blighted Sterling and the Australian Dollar that is increasingly a target of Chinese aggression. The greenback doesn't tend to fare too well when equity markets are rip-roaring while all of the others have strong and long-lived positive correlations with stocks.

One of the best examples was until recently, GBP/USD while AUD/USD and NZD/USD are still hard on the heels of the S&P 500 that had recovered all-but 1.3% of its -29.8% coronavirus collapse as of Thursday. One of the reasons these correlations exist is because professional investors who're able to buy stocks, tend to own at least some of the American market  - the largest of all - but often sell the Dollar simultaneously when they buy into it in order to protect themselves from currency fluctuations. 

Above: CAD/USD shown at daily intervals alongside S&P 500 stock index (black line).