Global Markets to Fed: No Rate Hike, the Strong Dollar Is Killing Us

There are many reasons for global markets to melt down, but one that doesn’t get enough attention is the strong dollar. In effect, global markets are telling the Federal Reserve: don’t raise rates–the strong dollar is killing us.

Here’s the dynamic that’s killing emerging markets’ currencies and stocks, the China Story and U.S. corporate profits. In the glory years of a declining U.S. dollar (USD), a vast global carry trade emerged as speculators borrowed money in USD and invested it in high-yield emerging market assets such as stocks, bonds and real estate.

This carry trade was a two-fer: not only were yields much higher in emerging markets, the appreciation of local currencies against the USD provided a currency gain on top of the higher yield.

As the yuan strengthened against the USD, an enormous river of capital flowed into China to take advantage of the revaluation and higher yields in China. How much of this money was borrowed USD is unknown, but it’s estimated that Chinese corporations alone borrowed $1 trillion in USD to profit from higher yields in China.

The virtuous benefits of a weakening USD extended to U.S. corporations, which reap 40% to 50% of their total profits from sales overseas. As the USD weakened, U.S. corporations reaped the currency gains every time they reported overseas sales in USD.

Everybody won with the weakening dollar, except the U.S. consumer, who paid more for imported goods.

But a funny thing happened in late summer 2014–the USD started rising against other currencies–by a lot. Suddenly all those profitable carry trades reversed.

Emerging markets remained in a trading range for much of 2011-2015, but the strengthening dollar was eating away at the carry trades beneath the surface.

Meanwhile, over in the S&P 500, stocks rose steadily from mid-2011 to mid-2015. But beneath the surface strength of the past year, market technicians noted a deterioration of indicators. Commentators started noting the rising dollar’s negative impact on U,S. corporate profits.

Now the carry trades have been abandoned, and market participants are looking at a Fed rate hike with fear and loathing. Why? The USD has already strengthened by 20%. A tick up in U.S. yields would only make the dollar more attractive globally, as traders would get the currency appreciation and a higher yield.

Global markets are puking at the prospect of higher yields in the U.S. The damage delivered by the rising dollar has been severe; a move higher from here might prove fatal to emerging markets and faltering U.S. corporate profits.

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  • Here is a great conversation that relates to this article Mr. Smith.

    Oct 13, 2014 Imperial Pax Americana

    What is the health of the American empire? How does the American empire differ from all other empires in history? What factor will inevitably be the collapse of the American empire? Is it supporting policies that actually play against US interests?

  • CORPORATE FASCISM: The Destruction of America’s Middle Class

    Fascism has taken over America with the merger of corporations and government whereby corporate power dominates. With the emergence of ever-larger multinational corporations — due to consolidation facilitated by the Federal Reserve’s endless ‘FIAT’ money — the corporatocracy has been in a position to literally purchase the U.S. Congress.

    02/13/2006 Who Owns the Corporation? Nobody!

  • Aug 26, 2015 Jim Grant: The Fed Turned the Stock Market Into a ‘Hall of Mirrors’

    “Confoundingly to me, people have come to be quite accepting of the value attached by fiat to these pieces of paper we call currency,” says Jim Grant, who’s the editor of Grant’s Interest Rate Observer and the author of The Forgotten Depression: The Crash That Cured Itself. “Are prices meant to be imposed from on high, or discovered by individuals acting spontaneously in markets? The readers and viewers of Reason known the answer to that but they’re regrettably in the minority.”Grant sat down with Reason magazine editor-in-chief Matt Welch on Tuesday to discuss the underlying causes of the recent market turbulence, why we don’t really “have interest rates anymore,” and how the classic jazz song “It’s Only a Paper Moon” provides a fitting metaphor for the equities market.

  • Anyone Home?

    Citigroup is now talking about the pressure emerging markets are having on US Treasury bonds, something I talked about before the huge stock rout on Monday. The biggest story here is as I mentioned, emerging markets are under incredible pressure from the Fed’s regime of ZIRP and low oil prices. Holding US Treasury bonds with a soaring dollar is causing imports from those countries to become more expensive, thus why we see a collapse in global trade consistent with the Asian export plunge of 60%.

    In order to counterbalance these negative effects, countries everywhere are selling US Treasury bonds and purchasing more of their own currencies. If no one buys these Treasuries that China is selling, the resulting pressure will increase the yield on a 10 year bond to over 250bps, an absolutely unsustainable amount. Furthermore, it is important to note that China selling Treasuries to shore up the value of their yuan while have a negative liquidity effect capital flow on the US bond market, which means that approximately 60% of the gains made by the Fed’s QE program will be wiped out completely, which means that they will either have to do QE4 or not raise rates at all, as emerging markets will likely dump more Treasuries.

    Hold on to your hats, folks. We have just seen the begging of this global bubble in credit and bonds, and nobody knows when the music will stop playing.