Seeking Alpha

The Fed Must Break The Dollar

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Includes: AUD, FXE, UDN, USDU, UUP
by: Michael A. Gayed, CFA
Summary

The latest economic data out of the United States and other developed countries points to a weakening outlook.

The Fed eased twice and is likely to continue on the easing path. But so are other central banks. As a result, the Dollar Index ($USD) remains bid.

With the Fed willing to shrink the interest rate differential and the Macron gap still open, the 100 level on the Dollar Index might be too strong of a resistance.

Two things are as big as the man who possesses them – neither bigger nor smaller. One is a minute, the other a dollar. – Channing Pollock

As the last quarter of the year started, traders’ attention turns to Brexit and further US-China trade war developments. The latest economic data out of the United States and other developed countries points to a weakening outlook.

With a manufacturing sector contracting strongly and a weakening services one, the pressure builds on the Fed to keep cutting rates.

The Fed eased twice and is likely to continue on the easing path. But so are other central banks. As a result, the Dollar Index ($USD) remains bid.

In one of the latest Lead-Lag Reports, I pointed out that the dollar (UUP) is in a steady uptrend for nearly a year and a half. As the 100 psychological level attracts, the mid-October US tariffs increase on Chinese goods might provide the excuse for reaching the level. Will it hold?

It bounced from dynamic support at the start of 2018, trending higher ever since.

Moreover, it emerged out of the last recession stronger, despite various QE rounds from the Fed. If the economic outlook worsens further and a recession does strike again, chances are that investors will bid the Dollar Index further.

But to understand the Dollar Index, one must reflect on its composition. Almost sixty percent of it is the Euro, while currencies like the Australian Dollar (AUD) have no say in the Dollar Index's value. In other words, the EURUSD currency pair is an excellent benchmark for an educated guess about its future direction.

As I pointed out in one of the previous articles here on Seeking Alpha, the EURUSD (FXE) sits at an inflection point. From a macro perspective, the ECB and Fed diverged for years in their monetary policies. It is no wonder the EURUSD dropped from 1.25 to below 1.10 on the back of the huge interest rate differential.

But the drop looks like a falling wedge, a well-known technical pattern pointing to a reversal. With the Fed willing to shrink the interest rate differential and the Macron gap still open, the 100 level on the Dollar Index might be too strong of a resistance to break on the first attempt.

If we add the likely pressure Trump will put on Fed moving forward, the chances are that the 100 level will cap the two-year-long Dollar Index advance. And that might be just what the US economy needs to regain international competitiveness.

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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.

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