Fed
chief Jerome Powell’s hawkish speech after the regulator decided to leave the
policy rate unchanged, to put it mildly, did not inspire investors.
The economy is already suffering the consequences
of tight monetary policy, with a growing number of corporate bankruptcies and
rising overhead costs. And now, there are even more rate hikes on the
horizon.
It is
clear that, in time, this could lead to a crisis. Perhaps not as severe as that
of 2008, but negative consequences are inevitable unless it is at the expense
of future generations.
More
specifically, if a recession threat arises, the Fed could again resort to
expanding its balance sheet through QE.
However,
this will undermine the gains made over the past year. The bottom line is that
to achieve price stability and avoid further inflation of the country’s debt
bubble, the regulator will have to allow some sort of recession.
Otherwise,
the regulator will find itself trapped in a vicious cycle: A black swan event
occurs that poses a threat to financial stability, the Fed addresses it, but
then a new problem arises, or an older one resurfaces.
Considering
all this, investors have concluded that the interest rate may rise again and
remain at an elevated level for an extended period, thus increasing the bet on
the US Dollar.
Meanwhile,
the attractiveness of US Treasury bonds, on the other hand, has
declined again, and TMF (Direxion Daily 20+ Year Treasury Bull 3X Shares) has
reached new lows.
The
question now is what will happen next regarding what the rising dollar will
mean for the global economy.
Starting
with the U.S., the cost of export goods, including components for manufacturers
and consumer imports, will become cheaper, which is an advantage in the fight
against inflation.
On the
other hand, a stronger dollar makes U.S. goods and services less competitive in
the international marketplace.
This
could lead to lower sales and, consequently, lower incomes. As a result,
economic growth could slow, which aligns with the Federal Reserve’s objectives.
Overall, we could say that a strong dollar currently benefits the United
States.
Talking
about the impact on other countries, with a stronger dollar, it becomes more
expensive for governments to pay their debts using their local
currencies.
This
could potentially increase the likelihood of sovereign defaults in some nations. The dollar
could continue gaining momentum due to the second wave of inflation, driven by
rising gasoline prices and a deteriorating economic outlook.
Remember
that an increase in recession risk could lead investors to seek safer assets,
including cash. Therefore, we
could see the DXY above the 107 level over time.
It is
also true that once the worst-case scenario occurs, investor sentiment could
change dramatically, as dictated by the “buy for new, sell for fact”
phenomenon.
What
should conservative investors do?
The best
thing to do in the current uncertainty is to follow incoming macro indicators,
as the data will suggest the direction of Fed policy and the overall outlook
for the economy.