We’ve observed several times so far this year, most recently in Weekly Update 20220903, that the declines in asset prices have so far not so much reflected a decline in asset values as an increase in the value of the unit of account … if your unit of account is the US dollar. It simply takes fewer bigger dollars to buy the same stuff. This dollar strength has also been the main Synthetic Systems miss … while the runs through the beginning of this year did indeed anticipate dollar strength, reflected in the rising Bills plot, they substantially ‘misunderestimated’ it.
That strength has continued. Conventional finance refers to “the dollar” in forex terms … “the dollar” is said to be “strong” or “weak” if it is appreciating or depreciating relative to other currencies. Since other currencies themselves may be appreciating or depreciating, this narrow view is an inadequate or misleading indicator of what the overall market value of the dollar is doing. Here at Financology we look at the dollar in the broader context of all the world’s asset markets. But it often turns out that these viewpoints are consonant, and this is one of those times.
This Bloomberg article does a deeper dive into the forex aspect of this dollar strength. But make no mistake … this is true dollar appreciation, which we might even call deflation were the latter term not so laden with baggage. For an economy beset with consumer price inflation, this is good news. For individuals and institutions short USD (in debt, leveraged…) … not so much.
But not today.
Maybe this trend was a little too widely publicized to be consistently profitable, but the USD reversed course sharply lower today, down across the board, again both against other currencies and a broad swath of assets. The dollar rose in foreign exchange, it rose against stocks, against Treasuries, gold, silver, platinum … even digital bits of nothing … the conventional tail-wags-the-dog way of saying this is that all these other assets rose against the dollar.
There were a couple of conspicuous exceptions though … copper and oil declined. In light of the context, we’re compelled to conclude they fell outright and in their own right. If this were a trend and not merely a one session dump, we’d go even further and suggest it represents industrial retrenchment or economic weakness. This does not square with the stock price action … but again, it’s only one day. I call attention to it not because one day is significant but because it bears watching … if a similar pattern persists it could be confirmation that a more tectonic turning point is at hand.
Regardless, the Fed cannot be pleased with this kind of “upside” action in stocks, bonds, and in an array of physical commodities. To the extent it were to persist, the Fed should be expected to become even more hawkish. Jackson Hole was a clear indication Powell was not pleased with the rally in stocks and bonds. As we’ve observed on a number of occasions, the Fed appears to be glomming on to our long held tenet that asset prices lead consumer prices. Its explanation is vague and circuitous … “financial conditions” are the “transmission mechanism” for monetary policy to the real economy … it refers to falling asset prices as “tight” “financial conditions” that should help “slow” “the economy”, and ultimately bring down inflation. These fuzzy logical contortions are quasikeynesian claptrap, but in their own roundabout way they lead the Fed to the correct conclusion … falling asset prices are harbingers of relief from consumer price inflation. We prefer a more economical, Occam’s Razor formulation:
When the value of the dollar changes, asset prices are affected first, consumer prices later.