Falling Equities Still Key for U.S. Dollar

The intermarket relationship underpinning the US currency and global equities remains largely unhinged, with falling equities persisting as the lone saviour for the corroding US dollar. And so once again, the falling US dollar got a fresh respite from a falling stock market. Earlier on Wednesday, the dollar seemed to succumb to one of those typical selling waves after better than expected UK housing numbers, improving confidence figures in Australia and higher than expected Norwegian inflation -- all of which bolstered the rally of these currencies against the greenback. Such figures reduce the need for quantitative easing in these economies, which only add to a widening in their yield differential ahead of the US currency.

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The dollar had seemed to take a fresh turn for the worst after starting to stabilize late last week into Tuesday due to: (i) retreating risk appetite once markets realized the veracity of those better than expected payrolls; (ii) remarks from Eurozone, Switzerland, Canada and New Zealand officials expressing concerns with the rapid rise in their currencies; (iii) political stress tests imposed on British pound following the Labour Party's resounding defeats in the European elections as well as the ensuing resignations; and (iv) S&P's downgrade of Ireland's credit rating.

The above dynamics proved to be mere profit-taking opportunities for dollar shorts, before these embarked on fresh USD-selling, attempting to target the elusive $1.47, $1.70, $0.85 levels against EUR, GBP and AUD respectively. Wednesday's breaking news from Russia's central bank stating it would reduce the share of reserves invested in US Treasuries may have sounded as the usual jawboning from the central bank each time oil prices and the Ruble are undergoing a firm recovery. Remarkably, however, this was the first time for a credible official from a G10 nation to have actually announced the intention to reduce the USD share of its currency reserves. With US bond yields soaring to fresh 7-month highs, the fed has little choice but to step up its asset repurchase program beyond the existing $300 billion in US Treasuries. So far it has purchased half of that.

Dollar Support from Struggling Equities?

Selling the US dollar during neutral/positive risk positioning continues to be the order of the day as long as no systemic event prompts USD-bound repatriation flows. At the current juncture, a currency devaluation in Latvia (and speculation of subsequent devaluations in the Baltics) remains the best candidate for a durable dollar bounce-via a retreat in the euro. Recurring waves of substantial market deleveraging over the past 2 years have proven to be predominantly dollar-supportive as positions are unwound into USD-denominated cash holdings. But given the debasing impact of the Fed's treasury-purchase programs and the lack of any substantial declines in global risk appetite, the US currency has remained in a clear downtrend, shedding 12% from its April high in trade-weighted terms.

And so could dollar bulls find hope in falling equities? The above weekly charts of the FTSE-100 and the S&P500 show both indices well into their fifth week of consolidation, gaining 31% and 41% off the respective March lows. Both indices have closed above their 200-day MAs, but the consolidating nature of the recent moves suggests lack of momentum as illustrated via peaking stochastics. The Stochastic oscillator measures momentum via the way prices close relative to their highs and lows. As long as closing prices end well off their highs (and closer to their lows), oscillator indicators will tend to move lower.

Hapless talk/expectations of a Fed rate hike by year-end should weigh on equities, especially as consumer fundamentals fail to provide support on the jobs and credit sides. While "less bad" economic figures may have been sufficient in lifting equities off their 12-year lows, more than just "less bad" data are needed to sustain these 30-40% gains. This is especially important when never in post-war history have US major indices rallied over 25% during a recession.

The trend from eroding financials leadership is shown in the XLF Financial SPDR, which contains 84 stocks of banks, real estate and insurance companies. Since hitting 6-month highs in May, the XLF remained in consolidative mode, without regaining its 200-day moving average since October 2007. While financial stocks acted as the leader in supporting the rally in equities, they have now fallen behind their technology sectors, underperforming them over the past 4 weeks.

More signs of a tired market are illustrated in the 3 consecutive daily stars in the Dow, whereby the closing prices were 5-10 pts away from their opening price on Friday, Monday and Tuesday. Such signs of indecision occurring at the top of a +35% market suggest increased vulnerability to a retreat.

Wednesday's trading session is already providing the negative confirmation after such protracted indecision making in equities, but only concerted selling in equities is expected to lend credible safehaven support for the greenback. The euro's uptrend since mid April remains largely intact as the $1.3770-80 support held up in the face of this week's earlier retreat. Thus, we may well get a fresh source of short term buying in the dollar in the next few trading sessions, but resistance remains key at $1.3770 against the euro, $1.5770 against the pound and 81.50 in the dollar index.

Finance ministers at this weekend's G7 meeting in Italy could well discuss potential exit strategies of their central banks' quantitative easing policies. Yet these ministers may as well discuss the ensuing exit strategy adopted by forex traders away from the US dollar, which is fast becoming the prevailing trade in today's markets. Selling the dollar during neutral/positive risk positioning remains the order of the day as long as no substantial declines in equity indices prompt USD-bound repatriation flows. Verbal support for the dollar at the G7, pre-earnings selling in stocks and artificially strong subscription in this week's treasury auctions will do the trick to stabilize the dollar for now.

Comments

[rick12345:]

Rather than focusing on his relentless effort to inflate the dollar, Bernanke should concentrate on bolstering the economy and reducing the inflationary outlook. If the financial position of the US improves, the dollar will rise along with it, no later and no sooner.

Jun 11 08:01 AM

[cynewulf:]

First commentator ,please take note "relentless effort to inflate the dollar" is the same thing as " reducing the inflationary outlook", your fancy words don't fool people.

Jun 11 08:25 AM

[ain't no fo...:]

Ashraf, while I agree with the premise of your article, you have left out the ONLY factor that matters as far as equities go, and by extension your argument for the direction of the dollar.

That factor is J P Morgan. They have gunned the E-mini's virtually every single time US equities have started to back off the "rally" engineered by the FED and Treasury over the past 30-45 days. They have been a permanent prop under the stock market during that timeframe, and they have billions and billions of government $$ to inject anytime prices start to weaken. Most of the late day "miracle rallies" have been due to nothing more than JPM engineering, and NOBODY stays short going into the last hour anymore, they just sit back and place side bets on what exact minute the buy programs are going to roll in. And roll in they always do... most recently at 3:20 eastern.

Volume, internals, technicals, fundamentals all look and smell like yesterday's breakfast. But you know what? That doesn't matter one iota.

Tell me how long JPM works as a proxy for the US government to keep this market artificially propped up and I will not need stochastics or any other oscillator to tell you what the stock and USD markets will do.

Right now they OWN this thing, lock stock and barrel and until (IF!) that changes its more of the same.

Jun 11 10:06 AM

[sorgmot:]

Barrels of crude oil now serve as the world wide reserve currency.

Now is June 11, 2009.

That was easy wasn't it.

Now, does it matter what state they are in?
In a barrel?
In a tanker?
In the ground?
In who's ground?

It is an elegant solution to the reserves problem is it not?

Quickly, trade your US$ for crude oil barrels.

Good luck.

Jun 11 10:48 AM

[TradingHelp...:]

This site, Seeking Alpha, is just excellent. There is little need to surf around from the FT to Reuters to Bloomberg. There is enough intelligent analysis, like this article, to keep abreast of the economy, learn and form one's own opinion. My own view is that the USD will and has to weaken further. I am convinced that's what the Fed, and US Gov want. A weaker dollar will fix the trade deficit and indirectly, via higher dollar inflation, help erode the real value of the trillions of debt. Equities should stay firm. I am not saying the structural problems are easy to fix, but GDP is going to be positive QoQ in Q3 and that will provide the excuse for more speculators to take the S&P 500 on another leg up to 1,000. Globally, the economy is recovering well. First estimates for UK GDP in April were positive. (I don't mean better than before, I mean literally positive MoM). China is looking at 7% GDP growth in 2009. Inflationary pressures are build fast, globally, though the bears on this site can't, won't, see it yet.

Jun 11 11:39 AM

[Living4Divi...:]

Micheal Young - I agree with you (At least about the Dollar)

Ludwig Von Mises put it best when he said:
" There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crises should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

The problem is that it might encourage other currencies into a competitive devaluation. I still think the dollar will devalue.

On Jun 11 11:39 AM Michael Young wrote:
> My own view is that the USD will
> and has to weaken further. I am convinced that's what the Fed, and
> US Gov want. A weaker dollar will fix the trade deficit and indirectly,
> via higher dollar inflation, help erode the real value of the trillions
> of debt. Equities should stay firm. I am not saying the structural

Jun 11 12:58 PM

[xxxx:]

It is nice to see that some people are beginning to see what is going on here. I wish the "regular press" got hold of it. People should not be giving thumbs down for speaking the truth about this market. you can still trade this stick saves. Each time there is a selling effort it removes people from the market and each selling effort is less successful.


On Jun 11 10:06 AM wpdragon wrote:

> Ashraf, while I agree with the premise of your article, you have
> left out the ONLY factor that matters as far as equities go, and
> by extension your argument for the direction of the dollar.
>
> That factor is J P Morgan. They have gunned the E-mini's virtually
> every single time US equities have started to back off the "rally"
> engineered by the FED and Treasury over the past 30-45 days. They
> have been a permanent prop under the stock market during that timeframe,
> and they have billions and billions of government $$ to inject anytime
> prices start to weaken. Most of the late day "miracle rallies" have
> been due to nothing more than JPM engineering, and NOBODY stays short
> going into the last hour anymore, they just sit back and place side
> bets on what exact minute the buy programs are going to roll in.
> And roll in they always do... most recently at 3:20 eastern.
>
> Volume, internals, technicals, fundamentals all look and smell like
> yesterday's breakfast. But you know what? That doesn't matter one
> iota.
>
> Tell me how long JPM works as a proxy for the US government to keep
> this market artificially propped up and I will not need stochastics
> or any other oscillator to tell you what the stock and USD markets
> will do.
>
> Right now they OWN this thing, lock stock and barrel and until (IF!)
> that changes its more of the same.

Jun 11 01:52 PM

[Dave Wrixon:]

The volatility of crude over the last year suggestst that is exactly what has been going down.


On Jun 11 10:48 AM sorgmot wrote:

> Barrels of crude oil now serve as the world wide reserve currency.
>
>
> Now is June 11, 2009.
>
> That was easy wasn't it.
>
> Now, does it matter what state they are in?
> In a barrel?
> In a tanker?
> In the ground?
> In who's ground?
>
> It is an elegant solution to the reserves problem is it not?
>
> Quickly, trade your US$ for crude oil barrels.
>
> Good luck.

Jun 11 03:23 PM

[silverwood:]

Thanks Ashraf, for another good article. I would like to add to your comment " Verbal support for the dollar at the G7, pre-earnings selling in stocks and artificially strong subscription in this week's treasury auctions will do the trick to stabilize the dollar for now." Also keeping gold below $1000 and from making a new higher high from that of March 08. Bottom line the Fed has to pull a rabbit out of their hat to keep USD$ from going down and testing the 72 level.

Jun 12 03:24 AM

[johnbee:]

There has always been credit expansion since the days of barter only stopped. It's credit that makes the world go round and the manufacture of money to do it by different ruses. There have been many times since the world war 2 when there has been too much weight of money needing to find a home (emerging markets; the .net boom etc) but yet the money rolls in endlessly from pension schemes etc and a new way need be found to spend it, or create new credit. Each time the new investment areas are overdone and the dealers make their commissions on the back (up and down) and there is a correction for a year or two, but optimism and new methods and opportunities come about. Only when money is totally wiped out will the whole system disappear, such as in a war, but it won't because people need to work and will work and produce and even in war will produce munitions for low wages. Money is not wiped out this time (maybe 10% of overall value in the world at best). So investors will reappear (even if its GS and JPM with borrowed funds) to take advantage of prices at half what they were a year ago and are not as bad as in the '70's when markets fell even further (down 75%) and inflation repaid the debts and gave way to the boom '80's.
If you are in employment you will eat, and its only the welfare state
and impossible pension rates which create a false labour market. This market will come right again sure enough. Maybe not in 2009 but what is a year or two of downside in ten? There are endless improvements in technology to come through but the rewards will be shared by all the world, not just the West as before. That's the biggest problem the West need resolve for their peoples, as they will need be equal with others in the next decade or so. In China when I was there 4 years ago the supermarkets in Beijing were as good as in the West and the prie of a good size melon was 10 cents, so $50 a week salary goes a long a way. The $ need fall to repay US debts but Bernanke is letting it happen slowly and will not let US interest rates rise too fast to kill the recovery. It will take time for the $ not to be the No 1 reserve commodity as countries need unwrap their positions slowly and find another alternative that can be used successfully. If it was to be oil and there is limited production in the hands of a few then the rest of the world would be open to blackmail. You can at least print $'s when you need them,
without limit, and you can recall them also, but not so oil or gold.
#


On Jun 11 12:58 PM Living4Dividends wrote:

> Micheal Young - I agree with you (At least about the Dollar)
>
> Ludwig Von Mises put it best when he said:
> " There is no means of avoiding the final collapse of a boom brought
> about by credit expansion. The alternative is only whether the crises
> should come sooner as the result of a voluntary abandonment of further
> credit expansion, or later as a final and total catastrophe of the
> currency system involved."
>
> The problem is that it might encourage other currencies into a competitive
> devaluation. I still think the dollar will devalue.
>
> On Jun 11 11:39 AM Michael Young wrote:

Jun 12 06:47 AM