Dollar bulls have reasons to add to their positions after this week's comments from Fed Chairman Ben Bernanke. Overall, the tone from the Fed's voting members suggest tempered optimism for a recovery in the US economy and a declining needs for quantitative easing stimulus creating a bullish scenario for the PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP). Currently, the Fed's strategy for supporting the economy comes with monthly purchases of $85 billion in mortgage-backed securities. But at this stage we are seeing a growing segment of the Fed's voting members that see this as an unnecessary component of the economy.
Repercussions of Policy Changes
As long as these comments continue, a few things are certain. We will continue to see trader support for the US dollar, and profit taking at elevated levels will start to become a more attractive option for the S&P 500 (NYSEARCA:SPY), and should leave to selling opportunities in the benchmark index. This, however, is a bullish scenario for the PowerShares DB US Dollar Index Bullish , which should continue to see new highs in the later parts of this year. For forex traders, these pro-Dollar scenarios create a bearish scenario not only for the CurrencyShares Euro Trust (NYSEARCA:FXE) but for the commodity space, as well. Commodities like oil and gold are priced in US dollars, so arguments for strength in one asset will only call for weakness in the others.
A Strong Dollar's Effect on Gold, Oil, and XOM
Changes in monetary policy from the Federal Reserve are being seen in conjunction with declining manufacturing numbers out of China. China is the second largest consumer of oil, so declining manufacturing data is bearish for the commodity. Strength in the US dollar will only add to this bearish outlook and this creates selling opportunities in Gold (NYSEARCA:GLD), oil - which can be played using the iPath S&P GSCI Crude Oil Total Return (NYSEARCA:OIL) - and in the stocks of oil-producing companies like Exxon Mobil (NYSE:XOM).
When we look at the S&P 500, a removal of central bank stimulus leaves the index open to sharp moves to the downside, as this will limit the ability for US corporates to generate positive surprises in earnings. With the index still trading near its all-time highs, prices are ripe for a downside correction.
In Gold, the massive price declines so far this year have been well documented. Overall, market momentum is clearly focused on the downside, and any added prospects for Dollar strength equate to new lows for the year:
A stronger Dollar is also negative for oil, and with major trend changes in Chinese manufacturing, there is now a selling opportunity in iPath S&P GSCI Crude Oil Total Return :
Finally, the projected decline in Oil should negatively affect earnings in Exxon Mobil, which has already seen a major drop after hitting its long term highs above 93. This indicates further weakness for the year, and I am expecting a drop back into the sub-90 region.