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Are we heading for a collapse in sovereign debt markets?


The one consistent winning trade throughout 2022 has been the US dollar. As economic conditions continue to deteriorate and a global recession looks near, investors have steadily flocked to the dollar and dollar-denominated assets.

The Fed has been raising interest rates sooner and steeper than other major global central banks and that’s only helped strengthen demand for the greenback. As I write this, the dollar index is nearly at 110. Over the past half century, it’s only been at this level twice – the mid-1980s and the early 2000s.

Both of those periods were marked by economic crises. The mid-1980s had the start of the savings and loan crisis, while the early 2000s, of course, was the tech bubble. When all is said and done, I think the current economy could be marked by a tail event of its own – a collapse in sovereign debt.

I talked about this back in July with respect to emerging markets specifically, but I think it’s a good time to begin looking at this from a broader global view. With Japan still pumping trillions into its economy and tanking the yen in the process along with the energy crisis in Europe, there are some real concerns about how many of these economies can handle an adverse economic outcome.

Let’s start with the basics. Most sovereign governments borrow in US dollars. With interest rates at historic lows and governments worldwide printing unprecedented amounts of money to manage the COVID pandemic, financing was cheap and easy to come by. We see now what the combination of excess liquidity, a war in Ukraine and supply chain bottlenecks have done to the world economy.

Borrowing costs are now being forced higher rapidly to stifle inflation. That’s made borrowing more expensive and pushed some governments to the brink of insolvency.

When combined with the higher cost for food, the higher cost for oil and other energies and a higher cost of debt servicing, a stronger U.S. dollar, which has increased by 13% year-to-date and more than 18% over the past year relative to a basket of global currencies, could potentially cripple the fiscal health of these economies.

Consider the debt ratings on some of these countries even before everything that’s happened in 2022.

Let’s take a look at the chart evidence

Then it’s either here around 0.98-1.00 against EUR, or the two deeper targets at 0.82-0.85 or deep down at 0,56 – 0,58. I am not sure we would like this to happen. It would mean that the world is in really bad shape.

I know I am not too optimistic, but the deep solution means a collapse or Europe as we know it. But the PPO oscillator does open up for that possibility. The Stoch RSI is too fast and nervous to say anything longer term.

Looking at the USD against CHF – it supports the USD bullish setup – if it can turn, it has to be now!

So the deeper I look the better it gets for the USD – and worse for all commodities – gold, silver, copper – you name them. So the world outside Europe is in a deep depression against the USD – Europe might be following –  bad for stocks, bonds and commodities – or a turning point, of which we have no momentum indications yet. Just chart lines.

I guess the ECB meeting this week will be the trigger then. The US has always discounted in 75 bps and a Fed fund to top around 3.75 – that is really the best hope for markets these days – that everyone is long USD because of expectations of rising yields – which is already discounted to some extent – we don’t fully know.

Henrik Mikkelsen is the Investment Strategist and Developer with Iridis AG, an investment advisory firm in Switzerland.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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