Is the U.S. Dollar Really Predicting Future Doom?

A Colossal Event is Just Around the Financial Corner! Sounds like the pages of Zero Hedge pretty much every day... but it's actually courtesy of Business Insider:

"The dollar is set for its strongest quarterly strengthening since 1992, according to Bank of America, a good sign that a rate hike is around the corner.

When markets expect that U.S. interest rates will be hiked, it typically strengthens the dollar. That's because people rush to change other currencies into dollars -- they can make more money in dollar-denominated investments. The higher demand for the U.S. currency drives its value up.

In the past, significant dollar gains against other currencies have pretty much happened only during periods of extreme financial or geopolitical distress."

The proof? Well, they have a graph. Every time the dollar surges, financial distress follows… or alternatively, some financial events in the past have loosely coincided with dollar surges… or alternatively alternatively, the dollar has reacted to major financial events. The chart goes back a long time, just shows quarterly moves in the dollar, and it's very unclear what came first, or even how close in time we're actually talking.

Take 2008, for example: the Mother of All Ugly Markets -- at least since the '87 crash. The dollar surged in early 2008. Did it really "predict" the Lehman fiasco? I seem to remember we had already gotten very ugly earlier that year. Bear Stearns went bad that March, though it's kind of forgotten now, given how much worse everything got.

But whatever. I could make a much stronger case that the dollar action was more a reaction to what was going on in the credit markets than a predictor of anything. And I could make that case now. We know the Greece story ad nauseum. We know the Fed is tightening at some point. Is the dollar really predicting things that we already know and warning of future doom? Feels like a stretch.

It also feels like if something happens six months or a year from now, we can say, "Hey look, the dollar predicted it!" What I do know is that volatility is picking up a bit. I learned that from the TV, though.

Okay, not just the TV. I do watch the CBOE Volatility Index (VIX) a bit. And yes, it's nudging higher, but it's not exploding just yet, so no real signals. And that's not terribly reassuring. I'd rather see panic on tame down days then relative blahs.

VIX futures are taking it a bit more seriously. Here's how it looks now vs. Dec. 9, when VIX was at a similar level just before the volatility trend turned higher. It's an upslope, but no Colossal Financial Event priced in just yet (click chart to enlarge).

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.