Is the Hated U.S. Dollar About to Rally?

Few essays I’ve ever written have drawn as much ire as the ones in which I propose that the US Dollar might rally. The US Dollar is indeed hated, so hated that people will hate you just for considering that it might rally.

Virtually every day I receive emails from people asking me about the coming massive US Dollar devaluation or when the Zimbabwe-esque hyperinflation will hit. What’s striking about this is that I receive more of these sorts of emails today (when the Dollar’s at 76 or so) than I did last summer when the Dollar hit a 30-year low of 72.

In fact, the Dollar is so hated that it recently broke a nine-month downtrend and virtually no one noticed. I know you probably think I’m a jerk just for mentioning this, but you can see it for yourself:

Of course, this could simply be a “head fake” as the Dollar continues downward to test its 2008 lows. But I can’t help wondering if this recent move might be the start of something bigger: a potential Dollar rally that would catch 98% of the world off-guard (98% of investors are bearish on the greenback).

If you’ve been reading my essays from this week closely, you know that most of the stock market gains generated by the US markets have come from the Dollar losing value. Indeed, the US Dollar and the stock market have been trading at a near perfect inverse correlation for months now. Every day that stocks rise, the Dollar falls and vice-versa, which is why I’ve noticed that the US Dollar broke its downtrend the exact same time that US stocks broke their uptrend.

The market gods are not without their sense of irony. And how ironic would it be for the US Dollar (the most hated investment in the world) to be the one asset that might be about to rally, crushing stocks and commodities (both of which have rallied hard largely due to Dollar debasement)?

The issue now is if the Dollar remains above its former downtrend line. If it does, then we may in fact be seeing the above scenario play out. I realize that it’s somewhat absurd for me to even suggest the Dollar might rally after all the bailouts and stimulus. But isn’t it odd that the Dollar today is actually higher than it was in 2008 before the stimulus and bailout madness began? Shouldn’t the Dollar already have broken below its 2008 lows based on all the fiscal insanity going on?

Or is it possible, no matter how unexpected, that another financial Crisis is currently beginning to unfold, and the Dollar’s moves are a sign that the investors are already beginning to shift towards safe havens like they did in 2008?

I am not claiming this is the case. But the above charts indicate that something very odd is going on with the Dollar in relation to stocks. I’ll be watching this development very closely going forward.

I highly suggest you do, too. If the Dollar does rally, it’s going to catch everyone by surprise.

I hope this essay ensure that you’re not one of them.

Comments

[Dave Wrixon:]

No, the model is a fallicy. Down dips are never linear in the first place. You would expect the in an extended decline that the first section of the curve to be the steepest with a gradual flattening off towards the bottom. However, with dollar, it is about to get a discovery moment which is going to send it plunging more steeply than ever. The Dollar's decline will not be over until the BS about being a safe haven is not only disproven but forgotten.

Nov 06 11:03 AM

[Marli:]

Massive countertrend moves in spite of overwhelming fundamentals that point in the opposite direction are part and parcel of currency movements. This was one of the first lessons I ever learnt in trying to model currencies based on interest rate differentials, rate of change in the current account balance, debt-to-GDP ratios and other independent variables.

Short DXY, long everything else is not only a crowded trade (in which the greater the appearance that a trade is self-evidently risk free among all market participants, the more likely it is that a reversal will occur at some point) but it distorts the value of beta as a measure of non-systemic risk among portfolio managers because the illusory negative or statistically insignificant correlations are being funded by the same pool of liquidity overwhelmingly pegged to a single market strategy. It's only when the market collapses and asset price correlations approach 1 do participants realize that modern portfoflio theory breaks down during mass liquidation cycles. Many do not understand this, which is why if some traders will call the Ghostbusters and find religion if they ever see gold and the dollar march in lock step.

In short, Summers is right. A sudden reversal in the dollar is not only a significant possibility, but given the distribution of sentiment in the market, the time is ripe for 'the beast' to humble the permashorts. Will the dollar continue to decline on average over the next few years? A thousand times, yes! But there's a funny thing about averages.

They do not express variation.

Nov 06 12:30 PM

[Michael Clark:]

My charts are telling me similar things. They times they are a-changing...

seekingalpha.com/insta...

Nov 06 12:44 PM

[Roger Knights:]

Denninger is saying the same thing. Dollar bears should tighten their stops.

Nov 06 02:50 PM

[Mr. Big:]

There is certainly pressure for the dollar to rally. But the Fed keeps it at bay with its zero interest rate policy and it's VERY PUBLIC pledge to hold rates there for an extended period (whatever that is).

As long as the Fed continues to sing this tune, the US dollar will likely to stay weak or continue on a weakening trend as the dollar shorts gain more momentum. In tandem, the stock markets will continue to be ever-so-overvalued....... the Fed hints at the end of its easy money policy.

When that happens, the selling in the stock markets will be intense and the rally in the USD will be very strong. I wouldn't want to be caught short in USD, that's for sure....

Nov 06 03:02 PM

[Jasper M:]

It is the nature of the ends of movements that "virtually no one noticed".

Mr. Big, I think you over-rate the Feds capacity to control interest rates.

Nov 06 03:51 PM

[macro -N- i...:]

Marli is correct in that portfolio theory breaks down in mass correlation (1). However, if the markets are 9 mo. ahead of main street, and any rally in the dollar will spark a landslide, wouldn't now be the time that the frontrunners are getting in? 9 mo. ahead? It is constantly pointed out that it will be too late if we wait for the Fed wording before moving. The liquidity is already being removed, if only by debt repayment, decreased money velocity, and writedowns. A 60% recovery with no correction yet is a lot of gas by the fire too. That's prime fibonacci territory. Anticipation in the market is stronger than facts.

Nov 06 10:09 PM

[ryanclarke:]

Maybe Wall Street is concerned Uncle Ben is going to tell them to take some writedowns ... and kiss off some credit card and mortgage debt that Mr. Big Bank doesn't want to ... I believe this winter will be the defining point of the Obama presidency ... because if he allows the banks to sweep losses under the rug and post good numbers in Q4 ... the Saudis, Chavez, and Putin are going to want $150 drum for America's driving a gasoline car addiction ... and America is never going to enjoy "cheap gasoline" again ... because the rest of the world ... through foreign currency appreciation relative to the U.S. buck ... is going to get that cheap oil.

Nov 06 10:30 PM

[adan:]

regarding, from your article (nice article, gain, btw ;-)

"Or is it possible, no matter how unexpected, that another financial Crisis is currently beginning to unfold, and the Dollar’s moves are a sign that the investors are already beginning to shift towards safe havens like they did in 2008?" -

actually, in an interview last week by maria b of cnbc with geithner (sp?) he specifically mentioned the dollar as a refuge during crisis as proof it was strong enough, ie, fed didn't need to raise rates -

seems to me, they're counting on a crisis to "save" the dollar, for now -

what with the european banks in such bad shape, china's miracle development mostly accounting (gdp is added to when a loan is made) and make work (empty bldgs and factories that idle workers built), plus geo/military/political stuff popping up like geysers wanting to be volanoes, there's some soundness in the reasoning there -

just not a soundness that would build a lasting recovery or trust and faith in our financial system, or that or currency would once again be a reliable store of value for our work....

Nov 07 08:34 AM

[Mr. G:]

Everyone talks about the dollar as if there is some overseer at a master contol switch that makes the decision while forgetting that the dollar index is traded against a basket of currencies, and its fair market value is determined by traders who determine the dollars value by market psycology, that is, the majority of traders controlling the direction of price.

The recent trend reversal was probably a massive liquidation by short sellers covering their bets because of all the chatter about dollar reversal. As the US economic indicators reveal confusing news, I would expect the dollar to consolidate which appears to be the case now. Traders are looking for positive news from the economic indicators before they are willing to bid the dollar higher.

Nov 07 10:44 AM

[malcolmb14:]

Plot a weekly chart , then throw volume on that chart

I thought as of week before last 'wow dollar is going to kick some butt' as the volume was higher than the 2008 lows.

This week we saw a massive amount of selling at 76.5 and we ended the week with an ultra high volume doji , which if you plot a down trend line since March highs , tested this line.

I believe the usd is destined to test demand at 72 before turning around. There is a support zone at 75.40 but once we have a weekly close below that 72 it is

Nov 07 11:49 AM

[Cash999:]

1) The DOW/USD inverse relationship is perplexing to me. If US stocks and other assets are in high demand, shouldn't it translate into higher Dollar demand as well?

2) Mr. Summer's implication that US equity surge is due to Dollar debasement is not understandable because other equity markets have also surged equally, while their currencies have gained Vs. the USD.

3) Maybe this inverse relationship is only a short-term happenstance and likely to breakdown. Assets denominated in competing currencies, especially Euro, which is 57% of the basket, do not offer any significant interest rate advantage.

4) Maybe the Dollar debasement scenario has been overplayed at this time.

Nov 07 11:52 AM

[Mr. G:]

Regarding the comments about raising the FED rate ,I recall lowering as being a stimulus to the US economy because it encourages easier lending to stimulate business. In the current environment, raising the rate would be detrimental until banks lend again, which they are not.

Raising the rate is frequently a response to slow the economy down to prevent inflation. As anyone can see, traditional thinkinking suffers when the markets are out of wack. GI

Nov 07 01:36 PM

[David White:]

Great article. I concur. There is a strong likelihood that the dollar will rally. First there is the huge negative sentiment against the USD. This should work in the contrarian way to bottom the USD. Prechter has been predicting this. Next the equities markets have risen so much so quickly, they are likely to retrace soon. When this happens, the USD/US Treasuries should benefit as a safe haven play. The recent unemployment figure of 10.2% would tend to lend credence to a near term safe haven play. Third the US economy does generally seem to be recovering "slowly", which tends to hold inflation in check (allows the USD to move up as the economy improves). Fourth the Fed has been slowly removing money from the money supply since June 2009 (making USD's more scarce -- supply and demand). It has also begun to remove stimulatory measures, which effectively monetized debt. Eventually it will begin to raise interest rates. All of these actions would generally tend to push the USD higher. Finally there is a USD carry trade. When the USD starts to go up, there is likely to be a "short squeeze". The result should be a farther faster rise than many envision.

Nov 07 04:50 PM

[TeresaE:]

Last fall, when the dollar went from tanking to rallying, pundits were screaming about "safe havens."

Even as they ignored the TRILLIONs that Ben was flooding into Central Banks around the world (and where, btw, is the accounting of THAT fact?).

So, Bankers had these trillions of dollars, yet the value was low. Debase your own currency and use the increased value freely printed USD to fix things.

Watch for this to happen when China makes its last play against us. And they are closely watching WDC and our health care debacle has to be a sure sign to get out while the getting is good.

Nov 07 07:12 PM

[Steven Vincent:]

Here I was thinking that I was one of only two (potential) dollar bulls in existence. Now I see that there are at least 3 of us! Welcome to our exclusive club of the contrarians.

www.TheBullBear.com

Nov 07 08:45 PM

[Steven Vincent:]

The first phase of a dollar rally will likely be associated with a stock market/risk asset selloff. After a retracement as stocks bounce, the dollar rally will continue together with stocks as the growth story overtakes the deflation and inflation stories. Demand for dollars based on expanding international trade and demand for dollar denominated assets will then drive it higher. Of course if the world growth scenario does not emerge then this scenario will not as well. But it is the one possibility that no one is even willing to consider.

www.TheBullBear.com


On Nov 07 11:52 AM Cash999 wrote:

> 1) The DOW/USD inverse relationship is perplexing to me. If US stocks
> and other assets are in high demand, shouldn't it translate into
> higher Dollar demand as well?
>
> 2) Mr. Summer's implication that US equity surge is due to Dollar
> debasement is not understandable because other equity markets have
> also surged equally, while their currencies have gained Vs. the USD.
>
>
> 3) Maybe this inverse relationship is only a short-term happenstance
> and likely to breakdown. Assets denominated in competing currencies,
> especially Euro, which is 57% of the basket, do not offer any significant
> interest rate advantage.
>
> 4) Maybe the Dollar debasement scenario has been overplayed at this
> time.

Nov 07 09:12 PM

[Moon Kil Woong:]

A rally in the dollar for a day a week or two will not change the long term trend driven by lax monetary policy. The only way to reverse that is to let interest rates move back to their normative value which is most definately above zirp.

Nov 07 11:50 PM

[dirtyharry:]

As someone else has already mentioned, you have overrated the ability of the Fed or the government at large to control the markets. Think back to 2008 when they passed a ban on shorting certain stocks. Surely, that would slow or even end the decline, right? In fact, the market crashed. It was a complete failure. Fundamentally, the dollar should fall - and it will. But in the very short term, a surprise dollar rally is exactly the kind of event Mr. Market likes to pull on unsuspecting masses.


On Nov 06 03:02 PM Mr. Big wrote:

> There is certainly pressure for the dollar to rally. But the Fed
> keeps it at bay with its zero interest rate policy and it's VERY
> PUBLIC pledge to hold rates there for an extended period (whatever
> that is).
>
> As long as the Fed continues to sing this tune, the US dollar will
> likely to stay weak or continue on a weakening trend as the dollar
> shorts gain more momentum. In tandem, the stock markets will continue
> to be ever-so-overvalued....... the Fed hints at the end of its easy
> money policy.
>
> When that happens, the selling in the stock markets will be intense
> and the rally in the USD will be very strong. I wouldn't want to
> be caught short in USD, that's for sure....

Nov 08 11:46 PM

[john"magee":]

I agree.I have shorted the s&p 3 weeks ago @1065 (sds 38.5)and I'm long dollar(uup 22.79).The rising wedge in the s&p, which broke allready should put the index back near 666. Dollar should test 80 on a falling wedge.

Nov 12 05:02 PM

[Trend Surfer:]

The dollar did a double bottom and completed 2nd bottom yesterday (Nov12) with a strong upwards +'ive belthold candle. The first of the dbl bottom was a morning star completed on Oct25. It is also noteworthy that a morningstar candle was completed 2 weeks ago on the weekly chart.

Far from being a certainty, it would seem that the probably of an interim dollar has been set. It remains to be seen whether we will see this come into fruition next week.

Nov 13 04:32 PM

[User 445135:]

USD headed for a 25-50% rally, roasting "longs" in equities, boiling gold bugs and the like.

I cant wait....the day the carry trade unwinds creeps ever closer....

Nov 14 07:13 PM