Market Perspective for March 6, 2015

All of the major stock indexes finished in record territory on Monday, but then trended lower as the week wore on. Even a surprisingly strong payroll number for February failed to spark a rally on Friday, as stocks slipped on concern that a Federal Reserve rate hike is now becoming more likely.

Payrolls increased by 295,000 jobs in February, well ahead of estimates of 240,000 new jobs. The official unemployment rate is down to 5.5 percent, though wage growth slowed to only 0.1 percent.  The Fed may use wage growth as an excuse to keep rates low, but investors reacted to the data by lifting interest rates and sending rate sensitive sectors such as utilities and real estate lower.

While stocks were subdued in their reaction to strong payroll data, currency markets were another story. The U.S. Dollar Index surged to a new 52-week high on the news, following a major breakout earlier in the week. This week, the U.S. Dollar Index broke a 30-year trend line going back to the peak in 1985. From a technical analysis perspective, this opens up the possibility of a 50 percent rally in the index, one that could see the euro fall near 50 cents to the dollar.

Helping to fuel this dollar rally is $9 trillion in non-bank debt held overseas, much of it in emerging markets. Those borrowers are watching their debt costs soar as the dollar rises and is further complicated because many of them do not earn U.S. dollars. They borrowed dollars because they expected the dollar would depreciate versus their countries’ currencies. Unable to earn dollars to repay their debt, these borrowers are likely to try to repay debt early or hedge their exposure in the currency markets. As they do so, they will push the dollar even higher versus foreign currencies.

To put the current move in perspective, from early 1997, when the dollar started to rapidly rise ahead of the Asian Crisis, to the end of the crisis in 1998, when the Federal Reserve helped bailout Long Term Capital Management by cutting interest rates amid the Internet stock bubble, the U.S. Dollar Index rallied approximately 21 percent. Since July of 2014, the U.S. dollar has already gained 21 percent. Some analysts think there isn’t as much risk as there was in 1997 because fewer countries have currencies pegged to the U.S. dollar, but the total amount of non-U.S. dollar debt has increased 30 times since the late 1990s. That could prove to be more than enough fuel for a major U.S. dollar rally even if we don’t see the same type of currency crises that dominated previously.

If you haven’t done so already, now is a good time to give your portfolio a check-up. If the current U.S. dollar rally continues as anticipated, it could be the most important factor for the financial markets over the next couple of years.

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