US Dollar Will Head Higher As QE2 Ends… How Will It Affect Your Portfolio?

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Here’s why…

QE2 is ending.  QE2, or quantitative easing, is the easy money policy driving the recovery in the stock market.  But the liquidity party ends this month.

The Fed is taking away the punch bowl.  Ben Bernanke, Chairman of the Federal Reserve, told us yesterday QE will expire in June...

This is a big shift towards tighter monetary policy… and we’ll see a couple of natural reactions.

First, US Bond yields will rise and bond prices will fall.

The fact is interest rates must rise.  They can only go up from near 0%!

As inflationary pressure mounts, the Federal Reserve will be forced to raise interest rates.  And all indicators point to higher inflation ahead…

As a matter of fact, Bill Gross sees the writing on the wall for interest rates.  Bill Gross runs the world’s largest bond fund at Pimco.  So when Bill recently shorted US interest rate swaps, it was a big deal.  His rationale reflects this logic… interest rates have nowhere to go but up.

Second, as the Fed increases interest rates, or as the markets anticipate a rate hike, we’ll see the US Dollar rise.

Interest rate hikes always attract investors into the US Dollar.

There’s nothing complex about the idea.  As interest rates rise in US debt securities, they become more attractive to foreign investors.  Remember, you can’t buy US treasuries with Euros or Pesos, so to capture the higher rates, demand for the US Dollar jumps.

Now, you can see how bonds are at risk.  But they’re not the only assets in danger of falling…

Equities are at risk as well.

In the chart below, you’ll see how the US Dollar and S&P 500 move against each other.


An inverse relationship has developed over the past three years.  And the relationship even held true in early May when the S&P was falling and the dollar was climbing.

It’s a pretty strong inverse relationship between the S&P 500 Index and the US Dollar.

Now, I’ve made a solid case for a stronger US Dollar with the disappearance of QE2 and tighter monetary policy.  It seems pretty clear to me as the US Dollar rises, stocks will fall.  But there’s always a chance this relationship breaks.

Now, how do you protect your hard earned capital?

The first thing is to sell your bond funds.  I just showed you how bond prices will fall as interest rates rise.  So to protect your capital, selling now is the right play.

The second action to take is to start exiting equities!  It’s a tough call, but right now I only see the markets heading lower from here.  Preserve your capital by selling some of your stock holdings.

We are at the crossroads of a very serious financial correction…

And most times I’m happy to point you to another opportunity.

But this time around, you should get into cash.  As I said above, you should sell your stocks, ETFs, mutual funds, and bonds.  Get your capital into money market funds or other cash accounts.

Now’s not the time to be greedy.  We can always re-enter the markets once these global events are behind us.

•  Cocoa (Near $3,014/metric ton)

Cocoa has continued to stabilize, down from $3,800 per metric ton.  Since the geo-political risk in the Ivory Coast has subsided, Cocoa futures have once again stabilized.  Baring further disruption, Cocoa should continue to trade in this range during the coming months.

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