How to Determine the End of the Current U.S. Dollar Rally

The last time I wrote an article about the U.S. dollar on March 4th titled the “U.S. Dollar Vulnerable to a Sharp Decline Now”, the U.S. dollar index promptly plunged from 89 to 83 less than one week later. In that article I stated a critical multi-year intermediate resistance point that had to hold to not trigger further deep declines.

As it turned out, the USD index [EOD] approached the resistance line I pointed out but never breached it (for reasons I will explain below). Since mid-March, the USD has had a nice little rally to about 87. Though I’m not as confident as I was back on March 4th of the U.S. dollar turning down right away again, I do believe that a significant downturn is imminent in the very near future (within a window of perhaps one month).

As you can see from the chart below, the USD is now channeling back and forth in a fairly narrow channel that is highly likely to break to the downside. Currently, the USD stands at the top of the channel and a breakthrough of the bottom of the channel would likely give way to further steep declines.

Often the behavior of the U.S. dollar is very curious given its terrible fundamental outlook but when you consider that its major competitors, the British Pound Sterling and the Euro, are fundamentally as terrible currencies as the dollar, then it is easy to understand why the U.S. dollar can experience mini-rallies despite its awful fundamental outlook. However, the rallies of the USD are only curious to those that don’t understand the actions taken behind the scenes by the U.S. Federal Reserve and the U.S. Treasury to prop up the dollar.

When Wall Street giant Lehman Brothers filed for bankruptcy on September 15, 2008, in order to appease the world’s concerns about the soundness of the U.S. financial system and to specifically prop up the U.S. dollar, the U.S. Federal Reserve increased its swaps with foreign central banks nearly four times in a span of just two weeks to $233 billion.

Simply explained, the U.S. Federal Reserve engages in foreign currency swaps to increase the global supply of dollars to ensure that credit markets in foreign countries do not freeze up, as most large commercial transactions still occur in U.S. dollars and not foreign currencies. Thus the swaps not only ensure liquidity in foreign countries but also help support the U.S. dollar by ensuring that the fates of other foreign economies remain tied to the fate of the U.S. dollar.

Recently, on April 6th, the U.S. Federal Reserve again announced that they would be increasing the existing $314 billion of foreign currency swaps by another $287 billion of availability in Euros, Yen, British Pounds and Swiss Francs. The addition of $287 billion of availability brings the combined potential size of this foreign swap market to $600 billion, a figure that coincidentally matches the size of the foreign currency swaps assumed by the Federal Reserve last December, when the U.S. Dollar index plummeted below 78.

Back then, the huge accumulation of foreign currency swaps on behalf of the Federal Reserve quickly provided support to the collapsing dollar and was able to reverse its downward trend. Since it worked so well back then, the U.S. Federal Reserve is employing the same tactic to continue fueling a U.S. dollar rally now. So perhaps it is possible that the U.S. dollar could keep channeling up and down within the narrow channel I’ve drawn in the above chart until it meets resistance at 88 or 89 before breaking down definitively once again.

The only thing for certain at this point is that the long-term trend of the U.S. dollar is still downward and that the Feds are employing the help of other Central Banks to keep the U.S. dollar propped up. Yesterday, the European Central Bank [ECB] revealed the breadth of U.S. dollar manipulations when it reported that it had sold gold reserves to buy more dollar reserves in 2008. Ludicrously, in light of these revelations, the ECB also simultaneously reported that it had not intervened in currency markets since 2000. As the sale of gold and the additional purchase of U.S. dollar reserves support U.S. dollar strength, how the ECB can state that their conversion of gold reserves into dollar reserves does not qualify as currency market intervention is baffling.

Given the behind-the-scenes actions in the currency markets, we can be sure that the U.S. Dollar’s current rally has been artificially created and is not a product of free markets. However, the one characteristic common to all free-market interventions, whether executed by Central Banks or governments, is that while they can cause assets to buck the trend in the short-term, they almost always fail in the long-term. Thus keep an eye on the above channel and when, not if, the USD breaks down from this channel, this will mark the beginning of another sell-off.

Comments

[metricon:]

Agree with you, but what makes you think this manipulation will stop?

Apr 22 06:47 AM

[DONE_SONZ:]

Asset prices rise,wages stay the same,and currencies lose value.Open your eyes people.

Apr 22 08:05 AM

[TWOfold:]

Last country with a strong currency is a rotten egg.

Apr 22 09:12 AM

[PS Thoo:]

Great piece of insight view of the artificially supported Dollar! It's been a "myth" how the US Dollar can still gain strength despite the biggest turmoil in U.S.! In my view, U.S is technically bankrupt if not for the continuous printing of money! What a shame! It will serve no justice if any country were to get away with this unpunished.

I am of the opinion that US Dollar really does not deserve to be a global currency!

www.1012financialfreed...

However, with so much at stake (both economically and politically), I can't see how the manipulation behind the scene will end.

Apr 22 12:54 PM

[Jaysan:]

A hedge fund pal responded:

The Fed and the Chair of President Barack Obama’s Council of Economic Advisers, Dr. Christina Romer, WANT the dollar to fall, but slowly and in an orderly fashion, because without it the internal US economy must deflate to adjust for the decline in US wealth and productive capacity. Whether they can engineer a slight decline is another question.

Apr 22 02:24 PM

[lavalamp:]

"The only thing for certain at this point is that the long-term trend of the U.S. dollar is still downward".

In my opinion, nothing is certain, other than if the Fed loses their fight with deflation (as they well might be doing) the dollar will only gain in strength.

Of course the Fed has the ability to devalue the dollar or at least constrain its strength by buying it's own debt. But that game can be played by any central bank.

Apr 22 05:07 PM

[Alex Filonov:]

Your view on the dollar strength is not supported by dollar. I'd rather bet on dollar, I know Mr. Greenback better than you.

Apr 22 06:58 PM

[Allan Frain:]

There is nothing like Gold when the Competive Devaluation and Quantitative Easing games are being played.

Apr 23 06:14 AM

[Cliff Wachtel:]

Good article, would be better still if you would recommend a practical alternative. You correctly point out that other majors are in bad shape too. So what DO you suggest as a currency hold? Loonies, Aussies?

Eagerly awaiting your response. Cliff

Apr 24 01:56 AM