Why This Dollar Bull Could Turn Bearish (DIA, UUP, UDN, SPY, INDEXDJX:.DJI)
Jack Crooks: If you’ve been reading my comments on the dollar, you likely know I am long-term bullish based upon the fundamental outlook of the U.S. economy relative to its developed-market competitors. But what could change my bullish view, at least over a multi-week basis, would be more quantitative easing from the Fed.
No matter the seemingly negative unending consequences created by artificial interest rates and credit creation pulled out of thin air by the Fed, the big boys on Wall Street learned long ago not to worry about that stuff. To them it’s simple: Liquidity is the mother’s milk of stock rallies. If the Fed eases — buy!
The Pavlovian QE-Dog is barking — it’s a powerful conditioned reflex created by the Fed. And it could send the dollar plunging.
If you ever took a Psych 101 course, you likely came across Mr. Pavlov and his dog. If not, here is a brief summary of the famous experiment:
The concept for which Pavlov is famous is the “conditioned reflex” he developed jointly with his assistant Ivan Filippovitch Tolochinov in 1901. He discovered this concept when examining the rates of salivations among dogs.
Pavlov learned that when a bell was rung in subsequent time with food being presented to the dog in consecutive sequences, the dog would initially salivate when the food was presented. The dog would later come to associate the ringing of the bell with the presentation of the food and salivate upon the ringing of the bell.
The expectation of quantitative easing for fund managers is the same as the “ringing of the bell” for Pavlov’s dog.
So what is triggering this bell ringing? Of course, more bad U.S. economic news in the form of higher than expected jobless claims, which provide more evidence the U.S. job market is in trouble again; and maybe the growth momentum has hit a wall.
This news triggered the conditioned response created by Fed Chairman Ben Bernanke — threats to economic growth will be met with Quantitative Easing. No matter that the Fed hasn’t said it will initiate QE3. No facts yet. But fund managers are salivating just as Pavlov’s dog did to the food and bell ringing conditioned stimuli.
Nice to know your money is being run by people with the same conditioned reflex as a dog. Well, I guess worse things have been said about fund managers.
Mr. Pavlov won the 1904 Nobel Prize for his work. By the time we get to QE6, Mr. Bernanke is a shoe-in for the 2015 prize.
Question: What if Bernanke determines his legacy as Fed Chairman is ill served by winning Nobel in 2015? In other words, what if he realizes, and regrets, he has created the Mother-of-all-Moral-Hazards through his precise fine tuning of Pavlov’s “conditioned reflex” theory application to fund managers?
Ben explicitly stated a while back that one of the Fed’s implicit mandates is to help support consumer demand by doing what it can to help bid up financial assets, thereby stimulating the so-called “wealth effect” as a catalyst for real economy growth.
Well, that hasn’t worked …
Stocks have rallied. But the real economy is putting in the slowest recovery from a recession since the Great Depression.
Dow Jones Industrial Average
So why does QE talk matter to the U.S. dollar? Because another round of Fed QE would mean more dollar supply on the market; in effect it is the explicit use of the dollar as fuel for global liquidity. We have some history to show that QE is not good for the greenback.
Take a look at the chart below that shows dollar price action when the Fed announced quantitative easing the last two times around: QE1 began on 11/25/08, and QE2 began on 3/31/11. In both cases the dollar sold off sharply for several weeks.
U.S. Dollar Index Weekly
So, the $12,000,000,000,000 (U.S. stock market capitalization) question: Is the Fed going to feed the conditioned reflex or not?
Related: PowerShares DB US Dollar Index Bullish ETF (NYSEARCA:UUP), PowerShares DB US Dollar Index Bearish ETF (NYSEARCA:UDN), Dow Jones Industrial Average (INDEXDJX:.DJI), Dow Diamonds ETF (NYSEARCA:DIA), SPDR S&P 500 ETF (NYSEARCA:SPY).
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