Risk Off: Dollar Up, All Else Falling

26 ก.ย. 2022

[This is the 4th installment of “The Great Wall Street Repricing” series]

CBOT: Micro 10-Year Yield (10Y1!)
Last Friday, U.S. stocks plunged again as soaring interest rates and FX market turmoil fueled investor fears of a global recession.

The Dow fell below 30,000 and closed at 29,590, down 486 or -1.6%. S&P 500 broke through 3700 and settled at 3,697, down 1.72%. Nasdaq Composite lost nearly 200 points and closed at 10,868, down 1.80%. Russell 2000 finished at 1,679, down 2.48%.

On Wednesday, the Fed raised Fed Funds Rate by 75 basis points to 3.00-3.25% range. Market expected two more rate hikes totaling 125 bps in the November and December FOMC meetings, bringing it to 4.25-4.50% by year end.

U.S. Treasury yields surged this week after the Fed's move, with 2-year rate topping 4.2%, a 15-year high. 10-year Treasury yield is currently quoted at 3.687%.

Meanwhile, US dollar index (DXY) exceeded 113 points, its highest level since April 2002. Euro currency fell to 0.9688 against the dollar, a 20-year low. British pound closed at $1.08, a new low in more than three decades.

Global Market in a Risk-Off Mode
On August 29th, I pointed out that global financial markets are in a paradigm shift triggered by runaway inflation and high interest rate. All major assets would undergo “repricing”. The recent US CPI data and Fed rate hike help speed up this process.


The title chart at the top of this analysis shows year-to-date returns from major financial assets:
• US Dollar Index (DXY): +17.73%, at 20-year high
• S&P 500 (SPX): -22.72%, in a bear market territory
• WTI Crude Oil (CL1!): +3.05%. In March, crude oil gained 60% in response to geopolitical crisis. It turned south ever since the Fed began raising interest rate
• Gold (GC1!): -8.95%. Under a strong dollar, gold has become a risky asset being disposed off by investors.


• Euro (6E1!): -14.07%. With geopolitical risk compounding a recession, the economic outlook of the Euro-Zone countries is very gloomy
• High Grade Copper (HG1!): -23.77%. Copper demand will decline in the event of global recession. Futures market has fully priced this in
• Soybean (ZS1!): +6.54%. Corn futures was up 25% in June. But the gain was largely given away as the fear of recession outweighed the risk of food crisis

In a “flight to safety”, investors shift their assets out of stocks, bonds and commodities, into US dollars instead. With strong exchange rate and high interest rate, US dollar appears to be the only “safe haven” in market turmoil.

How to Invest in Dollar?
If you are holding financial assets in foreign currency, converting them into US dollar is a logical first step.

A risk-averted investor may put dollars into a flowing rate bank account, or purchase money market fund. In a defensive move, you park money in US dollar account until market stabilizes and new investment opportunities emerge. Don’t tie up your money in long-duration deposit, as interest rate is almost certainly going to rise.

An active investor may consider trading risk-free US treasury bonds. Other dollar bonds such as corporate bond, convertible bond and municipal bond are subject to repricing.

Bond price and bond yield are inversely related. As we expect yield to go up, a trade could be constructed by shorting a cash treasury bond, or shorting CBOT treasury bond futures.

CBOT Micro Yield Futures list for two consecutive months. They are more intuitive to trade. If you hold the view that treasury yield would rise, long the micro yield futures. November contract will begin trading next week.

Why do I prefer 10-Year (10Y1!) over 2-Year (2YY1!)? We are currently in an Inverted Yield Curve environment. October 2-Year Yield (2YYV2) is quoted at 4.196%, but the 10-year contract (10YV2) is quoted at 3.739%, 457 points lower. In my opinion, rate hikes are fully priced in on the 2YY quote, but 10Y may still have some upside potential.


The next FOMC meeting is November 1-2, and the rate decision would be announced at 2PM eastern time on November 2nd. The 10Y November contract may trade till the end of November.

Financial market is extremely volatile this year. Getting an information edge increases your odds of success in managing risk. I suggest leveraging real-time market data for a better gauge of market situation. TradingView users already have access to delayed data. A Pro user could upgrade to real-time CME market data for only $4 a month, a huge discount at the time of high inflation.

Happy Trading.

Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.