Fear is the key: If dollar rally continues, equity is a goner

Is fear creeping into the markets again? From the looks of the equity market, it does not seem so. Equities have been shrugging off bad news coming out of Europe and slowly and steadily creeping up. Over the past few days, the markets have generally fallen at opening, but then slowly regained their footing by the end of the day.

All this indicates that the equity market is complacent and confident that prices will rise. But in a different corner of the market, where the big boys play, traders and investors are getting risk averse.

[caption id=“attachment_181897” align=“alignleft” width=“380” caption=“The US treasury market and the US dollar are giving signals that the risky play of equities may be off the table. Reuters”]  [/caption]

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The US treasury market and the US dollar are giving signals that the risky play of equities may be off the table. On Friday, 10-year US treasury bond prices made a new high and the dollar index broke a key resistance level. The US dollar and treasuries are considered safe places to invest when the equity market is falling.

One of the key drivers of the rise in the US dollar and treasuries has been Standard & Poors’ decision to downgrade France - which is a signal to other European countries of upcoming rating cuts. But the US treasury and dollar market have been steadily moving up for the past few days even as the equity markets continued to rally. A rallying of safe havens and equities simultaneously is pretty unusual.

A look at the 10-year US treasury chart ( click here for chart ) tells us an interesting story. The market has been making higher lows, as shown by the pink arrows, but also notice that the prices made a new high. The same is true of the dollar index ( Click here for dollar index chart ). A higher low is when the recent low in price is higher than the previous low.

When prices make continuous higher lows it means that buyers are in control as sellers are unable to make new lows. So does this mean that we will see a continued rally of havens and a sell-off of risky assets.

Not so fast. Notice that both the dollar and treasuries rallied high on Friday but sold off. The dollar index is back in its resistance zone and 10-year treasuries did come back below their previous all-time high.

If both these markets close above last Friday’s highs next week and continue higher we could see a sell-off in equities. There are, however, a few factors that are not in favour of the equity bears. Gold, the other safe haven, is not rallying with any kind of strength.

The other factor is that both the US dollar, treasuries and equities have been going up in tandem over the past few days. This does not happen usually and completely skews the risk-safe haven interplay, leaving analysts scratching their heads.

On Friday, however, the risk-safe haven interplay between the markets mostly worked in tandem. As safe havens such as US treasuries and dollar rallied, equities sold off hard in the US when the markets opened. Then, later in the day, like it always happened in the recent past, equities rallied, which led to a sell-off in safe havens. Gold is the only safe haven that moved along with the equities and not inversely.

The coming week’s price action will hopefully give a clearer sense of direction and till such time it’s best not buy equities.

George Albert is Editor, www.capturetrends.com