King Dollar? Part 2

Includes: CRB, FXE, UUP
by: Arun Chopra CMT, CFA

A quick update to King Dollar?

Model now at equilibrium.

Direction will become dependent on if Fed uses front end or balance sheet to normalize policy.

I wrote about the trend break in the dollar (UUP) 3 months ago in King Dollar? Since that time we've seen a steady continuation of that trend as price has fallen to the low 90's.

With sentiment now on the floor and a decent swing reaching some exhaustion, its a good time to take another look at things. The initial dollar analysis included the commodity market that I thought would hold in much better than it initially did. Particularly given that the dollar never even bounced.

That said if we look closely, the commodity market (CRB) market snapped down and came right back. In fact if we look close, price is back above the 176 level had been focusing on. It's currently a big focus for me as the base continues to hold even if the chart is not that clean.

One of the main drivers of the trade was the dollar (UUP) model I use to get a sense of upside/downside pressure on the currency. Here was the chart at the time.

USD Model from May 2017

Today the main point is the model now at equilibrium. This gap close was almost exact speaking to the strength of the model itself. It's been a combination of the red line and black line converging, suggesting that upside pressure on the dollar is all but gone, but downside gap closing is over as well.

So where does this leave us? Well for one it is an oversold moment in the near term. But I am not super concerned with common sentiment indicators or what we all can see by looking at the chart. The bigger issue is with the model gap closed, and no real market drivers, we have to look to the Fed.

I've commented here before even though it's slightly outside the scope, that the Fed has decided to work on the balance sheet portion of policy so to as avoid any more dollar (UUP) strength. It is the front end hikes that were causing so much dislocation, particularly as the rest of the world stays with easy money policy. Here is a Q&A from a Goldman policy note around the same time as my first article on this topic. The key is to understand the dynamic between raising interest rates vs reducing reinvestment in the balance sheet and or selling assets.

Chart wise here is the process I am talking about. This is the idea and concept for what I am looking for. The numbers are not exact, we simply can't know, but the underlying monetary policy would then drive where I look on the chart. As of now it isn't clear the direction of this two fold policy (balance sheet and rates).

At times this can feel crazy, and I think to some extend even the fed isn't sure what levers they are going to pull. Trying to normalize post a financial crisis, with tepid data at best, and being one of the only countries to move leaves them in a challenging situation.

So....for brevity, here's how to trade the dollar (UUP) in a world of post crisis unconventional policy...

Disclosure: I am/we are long UUP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.