2022-04-26

The Early 1980s Dollar Setup Repeats?

This thought crossed my mind and I've haven't worked through it, so consider this a hot take. But what if the setup is similar to the early 1980s? The U.S. economy is the strongest of Europe, Japan and China. It is hiking rates and capable of going higher than those countries, more ver there's a case to be made for all of those currencies experiencing major devaluations if rates and/or inflation are going higher than expected.

Normally, I'd expect a lower dollar here. A pullback definitely likely. The problem I'm running into is that the Fed hasn't done anything yet. Nobody knows what is priced in. Maybe the market is running ahead with pricing in Fed policy, but maybe not. What if the starting point for the next dollar move is a new multi-year high? Another way of putting this is, what if the Fed does its job like Volcker did? Wouldn't that shock almost everyone currently in the market?

Here's a chart that should scare everyone: DXY compared to the spread between the U.S. and German 10-year government bonds.

What do you think? Can the Fed decouple from Europe, China and Japan and keep hiking? Would it? I expect the 10-yer to fall and catch down to German yields in a deflationary scenario, but again, what if the inflation isn't done? This would have to be the biggest shock for a market that is convinced in the death of the dollar. It's also possible USG would like to induce this outcome as part of a non-kinetic war on Russia-China. They seem like they're psychotic enough to go this route, but maybe not that intelligent. Then again, the string pullers behind the scenes understand this chart and what it would mean for the global economy and global markets.

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