Where to After GameStop Short-Squeeze Rattled Markets?

US Dollar Fundamental Forecast: Neutral

US Dollar consolidation continued as market volatility unfolded
Treasury yields may have been offsetting impact of rising stocks
Fundamental risks: fiscal stimulus, jobs report, short-squeezing

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Amid persistent declines in the US Dollar for the better part of the past 10 months, last week served as a reminder to investors of the kind of situation that tends to bode well for the Greenback. When volatility strikes and investors prioritize safety, the common choice of haven asset are Treasuries. Last week, the VIX ‘fear gauge’ temporarily spiked by the most in almost 3 years over the course of 24 hours.

This dynamic offered a boost to the US Dollar, but follow-through seemed lacking. What has been more interesting is the ‘bottoming’ in the Greenback since this year began. Well, at least relative to the broader trend since March 2020. This is despite gains in the Dow Jones, S&P 500 and tech-heavy Nasdaq Composite. Part of the leveling out in USD can be explained by Treasury yields, which remain important to watch ahead.

Expectations of larger-than-expected US fiscal stimulus sent longer-dated Treasury yields spiking earlier this month – see chart below. Rising rates can bode well for a currency, or at the very least slow its descent. That is why the Greenback may have been holding its ground despite gains in equities. But, there are warning signs ahead that may end up benefiting the US Dollar as it enters a consolidative phase.

President Joe Biden’s US$1.9 trillion Covid package may have to wait until at least the middle of March and its size is in question. That leaves the door open to disappointment in the near term. Meanwhile, surging retail investor trading in heavily-shorted stocks (such as GameStop and AMC) has been a red flag for hedge funds. According to Bloomberg, the latter are reducing equity exposure at the fastest pace since 2014.

It is possible that the “short-squeezing” witnessed last week contributed to the downturn in market sentiment. But reports that hedge funds are decreasing exposure could reduce bankruptcy risk. As such, it might be worth keeping an eye on stocks like GME and AMC in relation to broader stock market sentiment. This is as the Federal Reserve highlighted the risk of a moderating economy ahead of the coming week’s non-farm payrolls report.

Earnings also remain in play following what has been a rather rosy fourth-quarter season, likely helping to support the S&P 500 amid the recent volatility. US giants Alphabet and Amazon are on tap, alongside Alibaba.