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A Stronger U.S. Dollar Will Crush The Reflation Trade

By Michael KramerMarket OverviewMar 26, 2021 06:07AM ET
www.investing.com/analysis/a-stronger-us-dollar-will-crush-the-reflation-trade-200569663
A Stronger U.S. Dollar Will Crush The Reflation Trade
By Michael Kramer   |  Mar 26, 2021 06:07AM ET
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This article was written exclusively for Investing.com

The reflation trade has been hot as interest rates have soared. However, with parts of Europe going back into lockdown and ultra-dovish monetary policy from central banks worldwide, the dollar is on the rise. That is likely to kill the reflation and commodity-driven trade in the equity market. 

The declines have already started, with oil and copper prices plunging. This has led to a rotation out of energy and materials. It is also likely to lead to declines in multi-national stocks, as well as emerging markets. Even the financial sector may get sucked into this unwind, as banks have risen sharply. 

US Dollar Index Daily
US Dollar Index Daily

The Dollar’s Rise

The dollar’s gains have come as rates in the US have risen sharply in recent weeks as the prospect for better growth takes shape in the US, even while parts of Europe struggle to recover from the coronavirus pandemic. Thus, commodities prices have been hit hard, as they are negatively affected by the strong US currency and worries of weaker growth hurting demand.

This weakness has found its way into the reflation trade, with sectors like Energy, Industrials, and Materials seeing weakness this week. If the dollar continues to strengthen and global growth concerns persist, it could signal the end of the reflation trade. 

Additionally, emerging markets have been hit hard in recent trading sessions due to the stronger dollar. If the USD remains strong, it will likely weigh, even more, sending ETFs like the iShares MSCI Emerging Markets ETF (NYSE:EEM) lower. There is potentially a bearish pattern forming in the EEM ETF, known as a head and shoulders pattern. The ETF would need to drop below $51.50 to confirm this negative pattern, indicating lower prices lie ahead.

EEM Daily
EEM Daily

Banks May Falter Too

The bank stocks have also come under pressure. This despite yields stabilizing at higher levels and spreads widening. The group has rocketed higher, and at least over the short-term, is trading well ahead of itself.

Just this past week there have been increases in the put position for the Financial Select Sector SPDR® Fund (NYSE:XLF) on the $33 puts for expiration on Apr. 16. With the open interest rising by around 25,000 contracts, the data showing the puts were bought for about $0.60 per contract. It would suggest that the XLF drops to approximately $32.40 by the middle of April. 

Stocks like Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS) have risen in nearly a straight line since Oct. 30. Both currently rest on a significant uptrend that could lead to a substantial drop lower if broken. Additionally, they both have an RSI trending and diverging lower, suggesting momentum in the stocks have turned bearish.

Goldman Sachs Daily
Goldman Sachs Daily

Reflation Trade Finished?

If the dollar continues to strengthen, it will further weaken the reflation trade, causing a ripple effect through different parts of the equity market. Coupled with higher interest rates that have negatively impacted the technology sector too, the equity market could find itself in trouble.

If rates begin to ease and the dollar drops, it will allow for the reflation trade to resume, pushing stocks in those sectors to even higher levels. But in the absence of a reversal of the dollar or interest rates, the reflation trade could be over. That is likely to be terrible news for the rest of the equity market.

A Stronger U.S. Dollar Will Crush The Reflation Trade
 

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A Stronger U.S. Dollar Will Crush The Reflation Trade

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Comments (15)
Rémy Boulaye
RémySZ Mar 30, 2021 2:36PM ET
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My favorite article from this guy on 7 April 2020 :  "The Stock Market Rally Can't Be Trusted" https://seekingalpha.com/article/4336476-stock-market-rally-cant-be-trusted Wow ! Super analyse ! LOL. If you want to earn money, don't listen to this kind of guy.
Aryan Gurung
Aryan Gurung Mar 29, 2021 4:24AM ET
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Eric Si Tho
Eric Si Tho Mar 28, 2021 4:46AM ET
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Oh look its Kramer again.
DONGHUN LEE
DONGHUN LEE Mar 26, 2021 1:18PM ET
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? 😭Strong inflation will occur because the U.S. government releases a large amount of money, but the strong dollar will prevent it properly, causing it to go into reflation.
Akeem Adebayo
Akeem Adebayo Mar 26, 2021 1:18PM ET
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really why do you say so
Dan White
Dan White Mar 26, 2021 12:42PM ET
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I would not bet against materials and energy with a world-wide recovery underway. Sure" there will be ups and downs but a month from now, tgey will be making new highs. I see the US coning back very strong. We'll need lots more energy abd materials.
Jay Rhyder
Jay Rhyder Mar 26, 2021 12:42PM ET
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"Recovery" is all everyone is talking about and yet Coronavirus is making new highs in every single country in the world.... tons of new cases and even new variants of the Coronavirus are popping up everywhere... the bottom line is - I can assure you we are not in a state of "recovery". The entire world is still being affected by the Coronavirus, and it is still killing people, despite these cheap excuses for a vaccine that only ends up hurting or killing people.... I see a long arduous road ahead for most people.... Personally, I will wear a mask forever because I'm not accepting any covid vaccine...
Mox Mox
Mox Mox Mar 26, 2021 12:42PM ET
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Jay Rhyder you sound like a fringe nutter
Achlalt Khavchig
Achlalt Khavchig Mar 26, 2021 12:35PM ET
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Jay Rhyder
Jay Rhyder Mar 26, 2021 12:35PM ET
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hi buddy! o/
Achlalt Khavchig
Achlalt Khavchig Mar 26, 2021 12:34PM ET
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Barwon Saeed
Barwon Saeed Mar 26, 2021 12:34PM ET
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How
Gene Kret
Gene Kret Mar 26, 2021 8:39AM ET
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150 years press 2 for English.
Mike Caldera
Mike Caldera Mar 26, 2021 7:52AM ET
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USD It can do whatever it has to do but in the end it's going down ⬇️🔻 hard. I'll trade it right now for Metals.
Stephen Fa
Stephen Fa Mar 26, 2021 7:52AM ET
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Yes, with Fed Money Supply soaring and Washington spending like no tomorrow, it is only a question of time and when.
Frank Delano
Frank Delano Mar 26, 2021 7:52AM ET
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Only if others do it less
Rodolfo Barraco
Rodolfo Barraco Mar 26, 2021 7:35AM ET
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Agree. Now europe covid is notnenough to justify expensive dollar. Economy is only bouncing to pre covid and money printing is record. Dollar should be heading lower, market went nuts
Juan Pablo
Juan Pablo Mar 26, 2021 6:46AM ET
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And the paradox is that the stonger dollar might hit hard the reflation trade but if they do nothing then the forced interest rate hikes ***the bull run.
Juan Pablo
Juan Pablo Mar 26, 2021 6:44AM ET
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Besides, they need to cool off inflation via the dollar in order to avoid future rate increases. If the cyclical recovery gets ahead of itself and feeds then they may be forced to move much faster. They need a stronger dollar now at least for the time being.
Juan Pablo
Juan Pablo Mar 26, 2021 6:39AM ET
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Agreed, time is running out
Viral Tolat
geewhizkid Mar 26, 2021 6:12AM ET
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Higher interest rates will drive bank stocks up even with a higher dollar, but a higher dollar will put downward pressure on all US equities. Conversely a weaker EUR and JPY will be good for european and asian stocks.
 
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