The deliberate devaluation of the dollar, colliding with extreme cross-border imbalances and excessively high valuations, is brewing a volatility event.
Author: Capital Flows
Translation: Deep Tide TechFlow
Macro Report: A Storm is Coming
“What important truths do very few people agree with you on?”
This is a question I ask myself every day while studying the markets.
I have models regarding growth, inflation, liquidity, market positioning, and prices, but the ultimate core of macro analysis is the quality of ideas. Quantitative funds and emerging AI tools are eliminating every statistical inefficiency in the market, compressing the advantages that once existed. What remains is macro volatility expressed over longer time periods.
Truth
Let me share a truth that very few people agree with:
I believe that within the next 12 months, we will see a significant increase in macro volatility, surpassing that of 2022, the COVID-19 pandemic, and possibly even the 2008 financial crisis.
However, the source of this volatility will be the planned devaluation of the dollar against major currencies. Most people believe that a decline in the dollar or "dollar devaluation" will drive risk assets up, but the reality is quite the opposite. I believe this is the biggest risk in today’s market.
In the past, most investors thought that mortgages were too safe to trigger systemic panic, while also overlooking that credit default swaps (CDS) were too complex to matter. Now, complacency regarding the potential sources of dollar devaluation still exists in the market. Almost no one has delved into this devaluation mechanism, which could turn from a barometer into a real risk for asset prices. You can discover this blind spot by discussing the issue with people. They insist that a weaker dollar is always good for risk assets and assume that the Federal Reserve will intervene whenever serious problems arise. It is this mindset that makes a deliberately designed dollar devaluation more likely to lead to a decline in risk assets rather than an increase.
The Path Ahead
In this article, I will elaborate on how this mechanism works, how to identify the signals when this risk manifests, and which assets will be most affected (both positively and negatively).
It all boils down to the intersection of three major factors, accelerating as we approach 2026:
Liquidity imbalances caused by global cross-border capital flows leading to systemic vulnerabilities;
The Trump administration's stance on currency, geopolitics, and trade;
The appointment of a new Federal Reserve chair whose monetary policy will align with Trump’s negotiation strategies.
Roots of Imbalance
For years, uneven cross-border capital flows have created a structural liquidity imbalance. The key issue is not the scale of global debt, but how these capital flows have shaped balance sheets, making them inherently fragile. This dynamic is similar to the adjustable-rate mortgages before the global financial crisis (GFC). Once this imbalance begins to reverse, the structure of the system itself accelerates correction, liquidity rapidly dries up, and the entire process becomes uncontrollable. This is a mechanical fragility embedded in the system.
It all starts with the U.S. as the world’s only “buyer.” Due to the strong position of the dollar as a reserve currency, the U.S. can import goods at prices far below domestic production costs. Whenever the U.S. purchases goods from the rest of the world, it pays in dollars. In most cases, these dollars are reinvested by foreign holders into U.S. assets to maintain trade relations, as the U.S. market is almost the only option. After all, where else can you bet on the AI revolution, robotics, or people like Elon Musk?
This cycle repeats itself: the U.S. buys goods → pays dollars to foreigners → foreigners use these dollars to buy U.S. assets → the U.S. can continue to purchase more cheap goods because foreigners keep holding dollars and U.S. assets.
This cycle has led to severe imbalances, with the U.S. current account (the difference between imports and exports, the white line) already in an extreme state. On the other side of this phenomenon, foreign investment in U.S. assets (the blue line) has also reached a historical high:
When foreign investors indiscriminately buy U.S. assets to continue exporting goods and services to the U.S., this is why we see the valuation of the S&P 500 index (price-to-sales ratio) reaching historical highs:
Traditional stock valuation frameworks stem from the value investing philosophy advocated by Warren Buffett. This approach performs well during periods of limited global trade and low liquidity within the system. However, what is often overlooked is that global trade itself expands liquidity. From the perspective of economic accounts, one side of the current account corresponds to the other side of the capital account.
In practice, when two countries trade, their balance sheets guarantee each other, and these cross-border capital flows exert a powerful influence on asset prices.
For the U.S., as the world’s largest importer of goods, a large influx of capital into the U.S. is why the ratio of the total market capitalization to GDP is significantly higher than in the 1980s—an era defined by Benjamin Graham and David Dodd in "Security Analysis" that established the framework for value investing. This is not to say that valuation is unimportant, but rather that from the perspective of total market capitalization, this change is more driven by macro liquidity changes than by the so-called "Mr. Market's irrational behavior."
Before the outbreak of the global financial crisis (GFC), one of the main sources driving the fragile capital structure of the mortgage market was foreign investors purchasing U.S. private sector debt:
Michael Burry's bet on the "subprime mortgage crisis" during the global financial crisis was based on insights into fragile capital structures, with liquidity being the key factor repriced as domestic and cross-border capital flows changed. This is why I believe there is a very interesting connection between Michael Burry's current analysis and my ongoing analysis of cross-border liquidity.
Foreign investors are injecting more and more capital into the U.S., and whether through foreign capital inflows or passive investment inflows, it is increasingly concentrated in the top seven stocks in the S&P 500 index.
It is important to note the type of this imbalance. Brad Setser has provided an excellent analysis explaining how the dynamics of carry trades in cross-border capital flows have structurally triggered extreme complacency in the market:
Why is all this so important? Because many financial models (which I believe are incorrect) now assume that in the event of future financial instability—such as a sell-off in U.S. stocks or credit markets—the dollar will rise. This assumption makes it easier for investors to continue holding unhedged dollar assets.
This logic can be simply summarized as: Yes, my fund currently has a very high weight in U.S. products because the "dominance" of the U.S. in the global stock index is unquestionable, but this risk is partially offset by the natural hedge provided by the dollar. Because the dollar typically rises when bad news emerges. During significant stock market corrections (like in 2008 or 2020, although for different reasons), the dollar may strengthen, and hedging dollar risk effectively cancels out this natural hedge.
Conveniently, the expectation that the dollar serves as a hedge for the stock (or credit) market, based on past correlations, also raises current return rates. Because this provides a rationale for not hedging U.S. market exposure during times of high hedging costs.
However, the problem is that past correlations may not persist.
If the dollar's rise in 2008 was not due to its status as a reserve currency, but rather because financing currencies typically rise when carry trades are unwound (while the destination currencies typically fall), then investors should not assume that the dollar will continue to rise during future periods of instability.
One thing is certain: the U.S. is currently the recipient of most carry trades.
Foreign capital did not flow out of the U.S. during the global financial crisis
This is the key reason why today’s world is so different from the past: foreign investors' returns on the S&P 500 depend not only on the index's returns but also on currency returns. If the S&P 500 rises 10% in a year, but the dollar depreciates against the investor's local currency by the same magnitude, then for foreign investors, this does not mean a positive return.
Here is a comparison chart of the S&P 500 index (blue line) and the hedged S&P 500 index. It can be seen that considering currency changes significantly alters investment returns over the years. Now, imagine what would happen if these changes over the years were compressed into a short time period. This enormous risk driven by cross-border capital flows could be amplified.
This leads us to a catalyst that is accelerating towards us—it is putting global carry trades at risk: the Trump administration's stance on currency, geopolitics, and trade.
Trump, Currency, and Economic Warfare
At the beginning of this year, two very specific macro changes emerged, accelerating the accumulation of potential risks in the global balance of payments system.
We have seen the dollar depreciate and U.S. stocks decline simultaneously, driven by tariff policies and cross-border capital flows, rather than domestic default issues. This stems from the type of risk I mentioned earlier regarding imbalances. The real problem is that if the dollar depreciates while U.S. stocks are falling, any intervention by the Federal Reserve will further depress the dollar, which will almost inevitably amplify the downward pressure on U.S. stocks (contrary to the traditional view of the "Fed Put").
When the source of the sell-off is external and currency-based, the Federal Reserve's position will become more difficult. This phenomenon indicates that we have entered the "macro end game," where currency is becoming the asymmetric key pivot of everything.
Trump and Bessent are openly pushing for a weaker dollar and using tariffs as leverage to gain the upper hand in the economic conflict with China. If you haven't yet followed my previous research on China and its economic warfare against the U.S., you can watch my recorded YouTube video titled "The Geopolitical End Game."
The core argument is that China is deliberately undermining the industrial base of other countries to create dependency on China and leverage for its broader strategic goals.
From the moment Trump took office (red arrow), the dollar index (DXY) began to decline, and this is just the beginning.
It is noted that short-end real rates are one of the main factors driving the dollar index (DXY), which means that monetary policy and Trump's tariff policies are key drivers of this trend.
Trump needs the Federal Reserve to adopt a more accommodative stance in monetary policy, not only to stimulate the economy but also to weaken the dollar. This is one of the reasons he appointed Steven Miran to the Federal Reserve Board, as Miran has a deep understanding of how global trade operates.
What was the first thing Miran did upon taking office? He placed his dot plot projections a full 100 basis points below those of other Federal Open Market Committee (FOMC) members. This is a clear signal: he is extremely inclined towards a dovish stance and is trying to guide other members towards a more accommodative direction.
Core Argument:
There is a core dilemma here: the U.S. is in a real economic conflict with China and must respond actively, or it risks losing strategic dominance. However, the weak dollar policy achieved through extremely accommodative monetary policy and aggressive trade negotiations is a double-edged sword. In the short term, it can boost domestic liquidity, but it will also suppress cross-border capital flows.
A weak dollar may lead foreign investors to reduce their exposure to U.S. stocks as the dollar depreciates, as they need to adjust to new trade conditions and a changing foreign exchange environment. This places the U.S. on the edge of a cliff: one path is to confront China's economic aggression head-on, while the other risks a significant repricing of the U.S. stock market due to the dollar's depreciation against major currencies.
New Federal Reserve Chair, Midterm Elections, and Trump's "Great Game"
We are witnessing the formation of a global imbalance that is directly linked to cross-border capital flows and currency. Since Trump took office, this imbalance has accelerated as he began to confront the largest structural distortions in the system, including the economic conflict with China. These dynamics are not theoretical assumptions; they are already reshaping markets and global trade. All of this is paving the way for a catalytic event next year: the new Federal Reserve chair will take office during the midterm elections, and Trump will enter the last two years of his term, determined to leave a significant mark in U.S. history.
I believe Trump will push the Federal Reserve to adopt the most aggressive dovish monetary policy to achieve the goal of a weaker dollar until inflation risks force a policy reversal. Most investors assume that a dovish Federal Reserve is always good for the stock market, but this assumption only holds when the economy is resilient. Once dovish policies trigger adjustments in cross-border capital positions, this logic will collapse.
If you have followed my research, you will know that long-term rates always price in central bank policy errors. When the Federal Reserve cuts rates too aggressively, long-term yields rise, and the yield curve experiences bear steepening to counteract policy errors. The Federal Reserve currently has the advantage that inflation expectations (see chart: 2-year inflation swaps) have been declining for a month, changing the risk balance and allowing them to adopt a dovish stance in the short term without triggering significant inflationary pressure.
As inflation expectations decline, we have received news about the new Federal Reserve chair, who will take office next year and may align more closely with Miran's stance rather than the views of other Fed governors:
If the Federal Reserve adjusts the terminal rate (currently reflected in the eighth SOFR contract) to better align with changes in inflation expectations, this will begin to lower real rates and further weaken the dollar (because inflation risks have just declined, the Fed has room to do this).
We have already seen that the recent rise in real rates (white line) has slowed the trend of the dollar (blue line) declining, but this is creating greater imbalances, paving the way for further rate cuts, which will likely push the dollar lower.
If Trump wants to reverse global trade imbalances and confront China in the economic conflict and AI competition, he needs a significantly weaker dollar. Tariffs provide him with negotiating leverage, allowing him to reach trade agreements that align with the weak dollar strategy while maintaining U.S. dominance.
The problem is that Trump and Bessent must find a balance among multiple challenges: avoiding politically damaging outcomes before the midterm elections, managing a Federal Reserve that has multiple less dovish stances internally, while hoping that the weak dollar strategy does not trigger foreign investors to sell U.S. stocks, thereby widening credit spreads and impacting the fragile labor market. This combination easily pushes the economy to the brink of recession.
The greatest risk is that current market valuations are at historically extreme levels, making the stock market more sensitive to changes in liquidity than ever before. This is why I believe we are approaching a significant turning point in the next 12 months. Potential catalytic factors that could trigger a stock market sell-off are rapidly increasing.
“What important truths do very few people agree with you on?”
The market is entering a state of almost somnambulism towards a structural risk that is almost unpriced: a manipulated dollar devaluation, which will transform what investors perceive as tailwinds into the main source of volatility in the coming year. The complacency surrounding a weak dollar is reminiscent of the complacency surrounding mortgages before 2008, which is why a deliberate dollar devaluation could have a greater impact on risk assets than investors expect.
I firmly believe this is the most overlooked and misunderstood risk in the global market. I have been actively building models and strategies around this single tail event to massively short the market when a structural collapse truly occurs.
Timing the Macro Turning Point
What I want to do now is to directly link these ideas to specific signals that can reveal when particular risks are rising, especially when cross-border capital flows begin to change the structure of macro liquidity.
In the U.S. stock market, positioning unwinds frequently occur, but understanding the driving factors behind them determines the severity of the sell-off pressure. If the adjustments are driven by cross-border capital flows, the market's vulnerability will be greater, and the alertness to risk needs to be significantly heightened.
The following chart shows the main periods when cross-border capital positions began to exert greater sell-off pressure on the U.S. stock market. Monitoring this will be crucial:
Note that since the euro to dollar (EURUSD) rebound and the surge in call skew during the market sell-off in March, the market has maintained a higher baseline level of call skew. This elevated baseline is almost certainly related to potential structural position risks in cross-border capital flows.
Any time cross-border capital flows become a source of liquidity expansion or contraction, this is directly related to net flows through foreign exchange (FX). Understanding the specific positions of foreign investors' buying and selling behavior in the U.S. stock market is crucial, as this will become a signal for when risks begin to rise.
I recommend tracking this dynamic primarily through the factor models provided by https://www.liquidationnation.ai/. The fundamental performance of factors, sectors, and themes is a key signal for understanding how capital flows operate within the system.
This is especially important for the artificial intelligence (AI) theme, as an increasing amount of capital is disproportionately concentrated in this area:
To further explain the connections of these capital flows, I will release an interview with Jared Kubin for subscribers in the first week of December (you should follow him on Twitter: link). He is the founder of https://www.liquidationnation.ai/ and a valuable resource in my learning journey.
Key Signals for Cross-Border Sell-Offs
The dollar depreciates against major currency pairs while cross-asset implied volatility rises.
Monitoring the skew of major currency pairs will be a key confirmation signal, which can be tracked using the CVOL tool:
https://www.cmegroup.com/market-data/cme-group-benchmark-administration/cme-group-volatility-indexes.html
- As the dollar falls, the stock market also experiences sell-offs.
The downward pressure on the stock market may be led by high beta stocks or thematic sectors, while low-quality stocks will suffer greater impacts (which is also why you should pay attention to https://www.liquidationnation.ai/).
- Cross-asset and cross-border correlations may approach 1.
Even minor adjustments in the largest global imbalances can lead to high inter-asset correlation. Observing the performance of stock markets and factors in other countries will be crucial.
- Final signal: Federal Reserve liquidity injections lead to further dollar depreciation and exacerbate stock market sell-off pressure.
If the dollar depreciation caused by policy triggers domestic stagflation pressures, this situation will be even more dangerous.
Refer to Brad Setser's article: https://www.cfr.org/article/foreign-money-flowed-out-us-not-during-global-financial-crisis
Although gold and silver saw slight increases during the cross-border sell-off earlier this year, they still experienced sell-offs during a true market collapse, as they are cross-collateralized with the entire system. While holding gold and silver may have upside potential, they will not provide diversification benefits when the VIX (Volatility Index) truly spikes. The only way to profit is through active trading, holding hedge positions, shorting the dollar, and going long on volatility.
The biggest issue is that we are currently in a phase of the economic cycle where the real return on holding cash is becoming increasingly low. This situation systematically forces capital to move forward along the risk curve to establish net long positions before liquidity shifts. Timing this transition is crucial, as the risk of not holding stocks in a credit cycle is as significant as the risk of not having hedges or holding cash in a bear market.
(I currently hold long positions in gold, silver, and stocks, as liquidity drivers still have upside potential.
I have detailed this for paid subscribers:
https://www.capitalflowsresearch.com/p/equity-strategy-opening-new-macro)
The Macro End Game
The core message is simple: global markets are ignoring the single most important risk in this cycle. The deliberate devaluation of the dollar, colliding with extreme cross-border imbalances and excessive valuations, is brewing a volatility event, reminiscent of the complacency we saw before 2008. While you cannot predict the future, you can analyze the present correctly. Current signals indicate that pressure is gradually building beneath the surface.
Understanding these mechanisms is crucial, as it tells you which signals to pay attention to, and these signals will become more pronounced as risks approach. Awareness itself is an advantage. Most investors still assume that a weaker dollar will automatically benefit the market. This assumption is dangerous and incorrect today, much like the belief in 2007 that mortgages were "too safe." This is the silent beginning of the macro end game, where global liquidity structures and monetary dynamics will become the decisive driving forces for every major asset class.
Currently, I remain bullish on stocks, gold, and silver. But a storm is brewing. When my models begin to show a gradual rise in this risk, I will turn bearish on stocks and immediately inform subscribers of this shift.
If 2008 taught us anything, it is that warning signals can always be found, as long as you know where to look. By monitoring the right signals and understanding the underlying dynamics, you will be prepared when the tide turns.
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