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“The economy will surely be swept away by a tidal wave of corporate default” – Albert Edwards
Whereas, in 2007 most of the largest developed and emergent economies where all cresting at the same time (i.e. constructive interference), today there’s much greater dispersion in growth tracks between developed and emerging markets, in part, because of the policy differentials set in motion during and after the financial crisis.
Whether it was cyclical happenstance or by design, these differentials have naturally affected economies primarily through the currency markets, with the US dollar exerting the greatest influence over the past two years, as the Fed gradually removed their extraordinary policy accommodations introduced and emulated during and after the financial crisis. As the dust settled, the net effect from this atypical and drawn-out process manifested with significant positioning and newfound strength in the dollar, arguably as extreme as the US Dollar Index exhibited at its secular peak in 1985. And while the deflationists have viewed dollar strength as the natural consequence of our collective and impending debt-ageddon, we view things more pragmatically as these market disequilibriums will invariably trend with greater cyclical frequency, as central banks modulate policy from extraordinary postures in the trough of the long-term yield cycle.
Notwithstanding the relative structural symmetry leading into the yield trough, comparatively speaking, the dollar’s move from Q2 2014 exhibited the performance extreme that in the past (1985 and 2009) marked exhaustion reversals.
Not surprisingly, gold, which had led the broader reflationary trend since the initial rate hike last December, has retraced the entire move from earlier this month. Should the dollar begin to weaken again, we suspect that similar to the resumption of the uptrend in July 2009, gold will find support around current levels. Over the past several weeks, the inverse correlation between gold and the US dollar has begun to tighten again, which we expect will be bullish for gold and commodities in general.