We are witnessing historic intervention in the world markets by the major central banks. The Federal Reserve with its zero interest rate policy and qualitative easing, The Bank of Japan with its negative interest rates and currency intervention, and the European Central Bank with its negative interest rates and qualitative easing. In addition, talks of a 'Brexit' have caused the pound to tumble as uncertainty about the UK's future in Europe has investors nervous. After a big run in 2014 the USD has traded sideways for the past year consolidating those gains. The fundamentals that led to those gains have not changed and we should see those themes reemerge throughout 2016. The chart below show the PowerShares DB USD Bull ETF (NYSEARCA:UUP). UUP seeks to track changes in the level of the Deutsche Bank Long US Dollar Index, which tracks the U.S. dollar's performance against a basket of the six major world currencies - the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. Technically you can see that UUP has been range bound for the past year and is currently at the bottom of the range. Unless we see a significant push through the lower boundary we expect to see this downside hold and reverse.
The Federal Reserve is reiterating calls for rate hike increases
New York Fed President William Dudley reiterated to CNBC a call for a gradual increase in interest rates is appropriate. He added inflation will fall short of the Fed's 2 percent goal and a decline in inflation expectations was possible. Dudley also said several sectors of the economy are showing signs of softness but contrasted that to the balance of the world where he said "there is significant uncertainty about economic growth prospects abroad". That fact that the Federal Reserve is even in a position to talk about raising rates regardless of how gradual while other central banks are lowering their rates is the driving reason for the stronger dollar.
Negative Interest Rates in Europe Signal a Big Problem
Europe has seen anemic economic growth since the 2008 financial crisis. The aggressive monetary policies of the ECB especially the negative interest rates are seen as a means to deprecate the Euro and subsequently decrease the costs of exports. These steps signal the European economic growth is in trouble and the ECB is taking major steps to try to combat this issue. The ECB is trying to incentivize the banks to lend money and make EU countries products relatively more attractive due to a cheaper currency in an effort to spur domestic growth in the EU bloc. The ECB has also increased its monthly asset purchases to $80 Billion Euros and expanded its reach to purchase non-bank corporate bonds in an effort to further try to push growth on Europe. Although the Euro has found some strength recently I see this as just a normal pullback and continued consolidation of the USD strength. At these levels I do like Proshares Ultrashort Euro ETF (NYSEARCA:EUO). Barring an unforeseen break lower, I think the EUO is very near a medium term bottom.
The Bank of Japan is Trying Everything to Devalue the Yen
The BOJ has tried everything in its power to weaken the Yen. However, amid the global problems investors have actually given the Yen unforeseen strength recently. The BOJ would like a weaker Yen to increase the competitiveness of its exports. But even the move the negative interest rates have not had the intended consequences. Mohamed A. El-Erian writes of the lessons learned from Japan's Experiment with Negative Interest Rates. Although the results lately have been opposite of the BOJs goal. The fact remains the intent is clearly identified and we don't see the BOJ giving up any time soon and expect them to be successful at some point. I am mildly interested in the Powershares Ultrashort Yen ETF (NYSEARCA:YCS) at these levels. The risk being the Yen could gain more strength before weakening.
'Brexit' Fears Drive Pound to Multi Year Lows
The uncertainty surrounding Britain's referendum on the European Union is weighing heavily on the pound sterling. We expect the currency to remain weak until this uncertainty is removed. You can see this weakness reflected in the CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB).
We see the USD remaining strong because the balance of the world is weak. As long as the ECB and BOJ continue their negative interest rate policies both the Euro and Yen should follow suit with more weakness. Until the British referendum the uncertainty surrounding the Brexit should keep a lid on any upside to the pound sterling. I look to a period of continued consolidation of the 2014 USD gains and eventual breakout to the upside for UUP. Barring a significant break lower of the dollar index I think UUP and EUO are attractive at current levels.
Disclosure: I am/we are long UUP, EUO, FXB.
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.
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