Last year surprised many market participants following the 25-percent performance in global equities. The macro picture changed radically between December 2018, a year when 93% of all assets tracked by Deutsche Bank were down (figure 1, left frame), and the end of December 2019 when every asset registered a positive performance in both local currency and dollar terms. The aggressive cuts from central banks combined with the announcement of asset purchase programs brought back confidence in the market and equities registered one of their best performances of the past two decades. Figure 1 (right frame) shows that global liquidity was one of the major drivers of equities in 2019, up USD 4 trillion to over $80 trillion, according to Bloomberg.
In addition, we explained that the rise in uncertainty around the world in 2018 and 2019 constantly reduced growth expectations to the downside and increased demand for safe haven assets such as US Treasuries and the US dollar. In addition to the real interest rate differential between the US and the rest of the world, the broad US dollar index (NEER: Nominal Effective Exchange Rate) has been very sensitive to the dynamics of the economic and political uncertainty (EPU) globally (figure 2 , left frame). A rise in uncertainty generally lowers growth expectations and generates preference for dollars. To the exception of Greece and Russia, US equities were the best performers for 2019 as a stronger US dollar usually leads to an outperformance of US equities (SPY) relative to the rest of the world (ex-US) equities (VEU) (figure 2, right frame).
The Invesco DB USD Bullish ETF (UUP) is an ETF that tracks the performance of the US dollar relative to a broad range of currencies (main US trading partners) using USDX futures. Its excellent liquidity makes it easy to trade for investors who want to be invested in the currency market.
We expect the USD narrative to change in 2020. Figure 3 (left frame) shows that the performance of the US dollar has been mainly following the dynamics of the global economic activity. Yield curves (i.e. 2Y-10Y) bottomed at the end of August 2019, which was also marked by the peak of the USD; UUP has consolidated by nearly $1 to $26.2 in the past 5 months. Hence, an ease in uncertainty in 2020 with Trump focusing more on the election rather than the trade war dispute should continue to levitate the long-end of the government yield curves and therefore be negative for the greenback. Figure 3 (right frame) shows that the US dollar has been strengthening for the past 8 years now, which corresponds to a USD cycle historically. The dollar has been ranging between $21 and $27 since its inception in 2007, with $27 representing a strong resistance as you can see. Even though the dollar may receive some inflows in the short run on the back of sudden rise in risk-off sentiment, we do not expect the safe haven to rise significantly in the coming quarters and would therefore recommend investors to slowly move away from it.
While the $27 level represents the historical peak of the USD, it also represents the high of the last Elliott wave of our three-wave increasing pattern. Figure 4 shows that we have now entered into a bear market for UUP and that the 200-day simple moving average (SMA, green line), which has been acting as a strong support for the past two years, may now act as a resistance in the coming months. Any bull consolidation on the UUP may be seen as a good opportunity to enter a short position. We think that $26.40 represents a good entry level, for a first retest of the psychological $26 support keeping a tight stop at $26.75.
The weakness in the US dollar may push US inflation by a few ticks in the coming months. Even though we saw that leading indicators of core CPI have been trending lower in recent months (i.e., NY Fed Underlying Inflation Gauge), previous series of USD depreciation have led to a little increase in US core prices (figure 5, left frame). Many practitioners are expecting core CPI to start weakening this year; however, we think that we could get positive inflationary surprises this year if the weak USD scenario starts to materialize, which should lift up the 10Y yield towards 2.25%.
In addition, the weak USD dollar should continue to benefit EM equities in the coming year. We saw that the ADXY was flirting with a critical level last summer at around 102.50; figure 5 (right frame) shows that the ADXY has been co-moving strongly with EM equities over time and the peak reached in January 2018 also corresponds to the EM equities peak.
Source: Eikon Reuters, Bloomberg
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Disclosure: I am/we are long EURUSD. 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.