Last week, the U.S. Dollar Index reached a 52-week low. The sharp move lower in the dollar, spurred by last week's drop in the consumer price index, is already having major repercussions across all asset classes.
Why does the U.S. dollar exert so much influence on commodities, stocks, and bonds? Consider that investors use the greenback as a safe haven in times of risk aversion.
When those same investors are dumping the dollar, as they are now, they are embracing risk. When investors are willing to take on risk, they are courting its inseparable counterpart, reward.
While the latest round of dollar selling was ignited by last week's CPI report, technical traders have been anticipating this move for months. The chart of the U.S. Dollar Index is extraordinarily bearish, and features a massive head-and-shoulders pattern.
The head and shoulders formed over a 15-month period, and when support (black dotted line) finally broke last week, the buck dropped like a brick (shaded yellow).
The index is trading below 100 for the first time in over a year, and could continue falling to the low 90's.
Chart Source: Worden
There is a complex chain of events that begins with the falling dollar:
Effect On Commodities
To put it simply, if each individual dollar is losing value, as it is right now, then more dollars will be needed to purchase commodities. There are other factors in play, but in general, a weak dollar is bullish for commodities prices.
We are already seeing the effect of the weak dollar on commodities. Last week, as the dollar broke down, the Deutsche Bank Commodity Index Tracking Fund (DBC) was breaking above a bearish trendline that had capped the commodity ETF since November (black dotted line).
If the dollar continues to fall, as seems likely, then commodities prices are likely to keep rising.
Chart Source: Worden
Effect On Bonds
As the dollar tumbled last week, Treasuries rallied (shaded yellow). The benchmark 10-Year Note exploded higher from a key support level (black dotted line) as the dollar fell.
The move higher in Treasuries causes the yield on those instruments to fall, a reflection of future interest-rate expectations.
Chart Source: Worden
Effect On Stocks
When Treasury yields are high, the risk-free investment gains appeal, sometimes at the expense of stocks. However, as Treasury yields fall, stocks become more attractive by comparison. Because of this, a series of events that began with a weak dollar ends as a bullish tailwind for the stock market.
