Dollar Already Broke Out

| About: PowerShares DB (UUP)

Summary

To some the dollar looks like it will break out. We think it already did.

European investors demand dollars as a safe haven.

Some may be exiting dollar hedges needing to buy dollars.

The cycle can continue.

We had three bullish reports calling for a dollar (NYSEARCA:UUP) breakout since October 10th (See here, here, here). We think the strength can continue with investors running for cover from euros and European financial risk.

Here's Our Recent Calls

Click to enlarge

Source: Interactive Brokers

Above are our three recent calls that we were bullish on the dollar as we thought it could break out. The last call we needed it to start moving up to confirm and it did.

Here's What We See Now

Click to enlarge

Source: Interactive Brokers

As we zoom out on the dollar ETF UUP you can see the dollar has just broken out of a longer term base.

The action that decided where it failed and dropped back looks now a little more powerful than past tries.

We believe there is a fundamental reason for a bigger potential breakout.

Bonds Dropping Worry Europe: Investors Need Dollars

Dollars are seen as a safe haven.

The ECB is keeping rates low of course to drive the economy. An underlying need to drive the economy however is to keep weaker European banks on life support. Many European banks are struggling to stay afloat. Lower rates help keep them breathing.

A spike in yields and a drop in bond values are a major risk. This risk comes suddenly and unexpectedly.

As weaker banks in Europe have to deal with declining values of their bond holdings their financial health comes into question.

This fast sudden bond drop is a risk for the European banking system. If so it's a risk for the euro as well. That's why investors are clamoring for dollars as soon as bonds dropped. The two moves happened together.

We see two main reasons for European investors to need dollars.

1) Selling Euro Debt

2) Selling US debt

Selling Euro Debt

Selling Euro Debt means investors are worried what higher rates will mean for EU banks (as we said above).

Higher inflation could also stall ECB's bond buying. The ECB is the only buyer in town. If they stop buying (which we think inflation can cause) then the bond rout continues. Investors need to get ahead of that. That reminds them the Eurozone is weak and so they want dollars.

Exiting EU debt also could point to US debt demand to come. The US banks are perceived to be more stable than the EU system. Selling EU debt could cause diversification to want to buy US debt in the future.

Selling US Holdings

As European investors sell their EU exposure they probably sell some foreign exposure. That foreign exposure may have been hedged by shorting dollars.

Let's think about it.

If I'm an EU investor and own US debt I may want to hedge out my foreign exposure in that security by shorting the foreign currency and buying my own currency. That shorting of foreign currency cancels out my holding's foreign currency exposure. As I now sell that US debt I need to close out my currency hedge. That dollar short cover makes me need dollars.

Selling bonds begets dollar demand.

Conclusion

If bond routs continue the dollar should go up.

As inflation causes worry that the ECB will stall their historic buying campaign the dollar goes up.

We think the dollar has already broken out.

PRO TRADER: Price Rise December 1st. Free Two-week Trial

  • Click here for a free trial.

  • Directional calls on stock market, stocks, gold, oil, bonds, currencies, indexes and more.

  • Get in before we raise rates 15% on December 1st.

If you want Elazar's analysis on Seeking Alpha, scroll to the top of the article and hit "Follow." Elazar also writes real-time pieces as news is reported. If you want to be among the first updated check the box for "Real-time alerts on this author" under "Follow."

Disclaimer: All investments have many risks and can lose principal in the short and long term. This article is for information purposes only. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC and their related parties harmless. Any trading strategy can lose money and any investor should understand the risks.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.