US Dollar Rallies; Should Equity Investors Be Worried?

A lot of people are worried about the recent strength in the US dollar, and how this would affect the performance of risk assets, namely global stocks, commodities and precious metals. This is based on the theory that the dollar has been the weak currency of choice, with the accommodative policies of the US Fed, leading to a carry trade that invests in higher-yielding risk assets. Looking at the technical picture, we could see a rally to as much as $80.17 (38.2% Fibonacci Retracement level), but still see a large sideways trading range near the bottom (see chart below). So is the possibility of a strong or sideways (with lack of downside momentum) dollar going to be a huge detriment to stock market performance?
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Fundamentally, our friend Scott Grannis aka the "Calafia Beach Pundit" gives his reasons for why he thinks a strong dollar and stock market (positive correlation) can co-exist and is not a problem. First, he debunks the traditional dollar carry trade thesis. He rather attributes recent dollar weakness to increase in money velocity (banks are not hoarding cash anymore and are releasing cash into the system, thus the recent strength in equities is due to improvement in the economy and not due to a weak dollar!). He also says that if a strong dollar and stock market can co-exist, it means that the economic recovery is genuine and is standing on its own two feet, and higher stock prices are not a pure reliance on some speculative dollar carry trade. Also, a stronger US dollar could mean that interest rates are on the way up sooner rather than later, thus a vote of confidence that the economy is improving and can withstand higher rates. I would think that the stock market would initially react negatively (or go into a huge sideways range) to any US dollar rally (or hints of higher rates), but eventually this should mean that the economy is on the right track.


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