The Dollar Makes A Higher High And Struggles

Summary

• A bear market since the highest level since 2002.
• Every rally led to a new low.
• The bullish key reversal broke the pattern on a short-term basis.
• Year one of the bear market, six more to go.
• Three reasons for a lower dollar in the months ahead and an ETF that will rally in the face of a falling greenback.

In 2014, the U.S. Federal Reserve told markets that it would taper their program of quantitative easing which was a response to the 2008 financial crisis. QE was a program the Fed designed to stimulate the economy by encouraging spending and borrowing while inhibiting saving. At the same time, the central bank slashed interest rates to the lowest level in history sending the short-term Fed Funds rate to zero percent. Other countries around the world followed the Fed, and a tidal wave of liquidity flooded markets with capital to avoid a global recession, or worse.

The first move by the Fed in 2014 to taper the QE program led to an end to asset purchases and the first short-term rate hike in December 2015. However, the announcement of the intentions by the central bank caused the dollar to take off to the upside versus other world currencies. The dollar index rallied from lows at 78.93 in March 2014 reaching the 100.36 level in March 2015. The rally of over 27% in just ten months led to a period of consolidation where the U.S. currency eventually traded to a high of 103.815 in January 2017.

A bear market since the highest level since 2002

The first days of 2017 marked the top for the U.S. currency as it traded at the highest level in fifteen years.

Source: CQG

As the quarterly chart of the U.S. dollar index highlights, the index turned south at 103.815 and declined for five consecutive quarters reaching a low of 88.15 on January 25. When the greenback fell below the May 2016 low at 91.88, the last level of support, the bearish trend took hold of the dollar. Any attempt at a recovery has failed as selling has pushed it to lower lows over the past fourteen months.

Every rally led to a new low

Markets rarely move linearly, but currencies tend to trend for extended periods.

Source: CQG

The weekly chart of the index shows that there have been few respites from the bearish price action in the dollar. Since January 2017, there have been two attempts at a recovery. In the currency market. The first came in from late January 2017 through early March when the index rallied from a low of 99.195 to a high of 102.27; the failure to make a higher high took the index down to a low of 90.99 in September. The next recovery attempt took the dollar index to 95.07 in November, but it once again could not muster the strength to appreciate which led to the most recent low at the end of January at 88.15. Since then, the dollar has been flirting with the 91 level over recent sessions.

The bullish key reversal broke the pattern on a short-term basis

On Friday, February 16 the dollar index reached its most recent low at 88.15.

Source: CQG

The daily chart of the March dollar index futures contract shows that on the day of the most recent bottom, the dollar put in a bullish key reversal trading pattern. The pattern of lower highs that had been in place since early 2017, was broken when the index traded above the February 8 peak at 90.455. The index reached a high of 90.885 on March 1, but it was trading at the 90 level once again on Friday, March 2. It appears that the threat of a trade war over tariffs on steel and aluminum weighed on the dollar after the President announced he would sign an order to impose 25% and 10% tariffs on the ferrous and nonferrous metals respectively this week. Another failure in the dollar index will likely lead to a lower low which is consistent with the trading pattern in the U.S. currency that has been present since 1985.

Year one of the bear market, six more to go

The quarterly chart at the beginning of this piece shows that the dollar has fallen into a pattern of predictable price action for more than three decades.

From 1985 through 1992, a seven-year bear market in the index took it from 129.05 to a low of 78.43. A nine-year bull market followed with the index rising to 121.29 in 2001 after which it fell for another seven years to lows of 70.805 in 2008. Finally, the nine years following the 2008 bottom took the index to a high of 103.815 in January 2017. If this pattern holds, we are just one year into the next seven-year bearish trend in the U.S. currency which could last until 2024. History tends to repeat itself in markets, and at this time I believe there are three compelling reasons why the dollar index will continue to trend to the downside over coming months and years.

Three reasons for a lower dollar in the months ahead and an ETF that will rally in the face of a falling greenback

The first reason is that when a market has many reasons to rally and it does not, it reveals an underlying weakness in the asset. The primary determinate of the path of least resistance for a currency tends to be its interest rate differential when compared to other foreign exchange instruments. While the Fed has hiked interest rates by twenty-five basis points five times since December 2015 and has made its intentions clear that at least three more such hikes are coming in 2018, European and Japanese short-term rates have not budged from negative forty basis points. The rate differential has grown between the dollar and those currencies, which should provide support for the greenback, but it has not, and the dollar has declined in the face of widening rate differentially exposing its inherent weakness.

The second reason is that longer-term rates in the United States have begun to rise. In the final months of 2017, the Fed started a program to decrease the size of its swollen balance sheet by allowing the legacy of quantitative easing expire and roll off which amounts to a quantitative tightening of credit. For the better part of a decade, the U.S. central bank provided what amounted to a free put option on the bond market. The current policy of "balance sheet normalization" is both unprecedented and amounts to a tightening of credit by the central bank. At the same time, accommodative monetary policies in Europe and Japan continue to widen the gap on not only short-term rates, but the same situation is present on the longer end of the yield curve. Again, these factors should support the value of the dollar which offers a more attractive yield when compared to the other major world currencies, but it has not.

Finally, the administration has stated, on multiple occasions, that a lower dollar is good for American business. On the campaign trail, President Trump pointed to a strong dollar that worked against the interests of U.S. competition abroad. When it comes to trade policy, the dollar can be a useful tool for the administration. The latest low in the dollar index came in response to comments by U.S. Treasury Secretary Mnuchin at the Davos conference in January when he advocated for a weaker greenback in the interest of profits for U.S. multinational corporations. While the President backtracked on the comments, his past comments suggest that this administration does not subscribe to the "strong dollar" policies of previous administrations. Moreover, protectionist policies like tariffs could weigh on the U.S. currency in the weeks and months ahead.

It is likely that the European Central Bank has not acted to tighten credit by ending their QE program and increasing short-term rates from negative forty basis points over concerns about a strengthening euro. However, the euro currency has moved from almost parity against the dollar in late 2016 to its current level at over $1.23 as the market realizes that sooner or later, the ECB will need to respond to improving economic conditions by hiking rates. Once the ECB acts, it is possible that the dollar will take another leg to the downside if the greenback is unable to make progress by breaking the current trend of lower highs.

The inverse historical relationship between the dollar, which is the reserve currency of the world, and commodities prices, could be telling us that we are at the start of a secular bull market in raw materials that will take prices much higher over the coming months and years. If we are just one year into a bear market in the dollar, which is the benchmark pricing mechanism for commodities prices, the potential for significant gains in the prices of these staples is likely developing before our eyes.

Source: CQG

RJI is a $404 million commodities ETN product that trades an average an average of over 225,000 shares each day making it a liquid product. Since October 2007, the ETN has traded from a low of $4.08 to a high of $14.33 per share. At $5.48 on March 2, RJI is a lot closer to the lows than the highs. A continued bear market in the dollar for more than another half-decade could mean that this ETN has lots of upside and that risk/reward favors a long position.

Analyst’s 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.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

Comments

[mmkkgg]

G O L D !

[pgace123]

Petroyuan could also affect the dollar. Coming at the end of the month I believe.

[buddyrow4]

👍