Currencies Tell the Story

From the Desk of Ian Culley @IanCulley

The US dollar and interest rates are still two of the most important charts out there. You’re probably tired of hearing it, but their future direction impacts the entire marketplace.

And, believe it or not, the currency market provides a great read on both.

Bullish data points continue to roll in left and right, supporting dollar strength. From the Korean won and Singaporean dollar to the euro and the pound, the dollar seems to break out against another currency every few days. 

No matter where we look, the US dollar is dominating. 

When we evaluate the trends in emerging market commodity currencies, it reveals insight into the recent rise in interest rates. Instead of showing strength, these currencies are catching lower -- which doesn’t jibe with a rising rate environment.

Let’s take a look.

Here’s an overlay chart of the US 10-year yield and our Emerging Market Commodity Currency Index:

Notice how closely these two charts follow each other, with EM commodity currencies leading through the turns in 2016 and 2018.

That makes sense, given rising rates speak to economic growth and market environments that are generally favorable for cyclical stocks and commodities.

As you can see on the right-hand side of the chart, last year this historically strong relationship began to diverge.

In early June 2021, our index peaked around the same time as many economically sensitive areas like materials, industrials, and copper. That’s not a coincidence.

Meanwhile, rates kept cruising higher.

Now that many sectors and assets that benefit from rising rates are actually catching lower, it solidifies a risk-off tone and questions a sustainable rally in rates -- at least in the near term.

It happens that yields across the curve are also running into their former 2018 highs, a logical level to see some mean-reversion action. 

If we think rates are due to roll over -- and we do -- then we need to consider buying bonds.

It’s all about the defensive nature of the US dollar rally and the lack of confirming intermarket evidence supporting the rise in rates.

Historically speaking, there are a lot of things going on these days that we're not used to seeing during a rising rate environment.

Eventually, something has to give. And, right now, our money is on lower yields.

Stay tuned.

Thanks for reading.

As always, let us know what you think.

And be sure to download this week’s Currency Report!