The US dollar has fallen to a record low against the Euro and an 8 year low against the Japanese Yen this past week. Here are 5 reasons why I think the weakness will continue:
1. Non-Farm Payrolls Will Continue to Fall
For 2 months in a row, jobs decreased in the US economy. I expect these numbers to worsen over the next few months because the current state of the labor market is nothing compared to the 15 consecutive months of negative job losses between 2001 and 2002.
2. The Federal Reserve is on High Alert
Not only are Fed Fund futures pricing in a 98 percent chance of a 75bp rate cut on March 18th, but the Federal Reserve is on high alert. For lack of a better description, they are “freaking out.” Friday morning, they announced moves to pump 200 billion dollars into the banking system to ”address liquidity pressures in the funding markets.” Although they denied that this was related to the weak jobs report, the timing is certainly suspect. The announcement may have been aimed at preventing a non-farm payrolls induced collapse in the stock market, which worked for about an hour before stocks completely reversed all of its gains.
Two year bond yields are also currently yielding slightly more than 1.50 percent while the Fed Funds rate is at 3 percent. That difference of 150bp means that in order for the gap to be neutral, the Fed would need to immediately cut interest rates by 150bp. Since 1990, the average spread between the 2 year treasury rates and Fed funds is approximately +50bp and over the past 10 years, it is +25bp. Therefore it is not rocket science to see that a gap of -150bp is a huge discrepancy and tells us that the Fed could bring rates down to as low as 1.50 percent. Lower interest rates equal a lower US dollar.
3. Retail Sales Could be Negative Next Week
Retail sales could also be negative next week which would lead to another round of dollar selling. 34k jobs were cut from the retail sector and according to the following WSJ chart, sales at most retailers other than discounters have been weak. With gas prices skyrocketing, foreclosures hitting a record high, the labor market weakening and confidence at a record low, discretionary spending may be the last things on the consumer’s mind.
4. Speculators Still Trying to Pick a Top in the EUR/USD The latest FXCM Speculative Sentiment Index, which is a contrarian indicator, also calls for further gains in the Euro against the US dollar as speculative short positioning continues to grow. Retail traders are often times caught on the wrong side of the market as they struggle to pick top and bottoms. As indicated by this chart of positioning in the Euro, retail speculators turned net short the EURUSD at 1.25 and have remained short since then.
According to the technical Elliott Wave formation of the EUR/USD, a spike above 1.56 is very possible before dollar bulls see any relief.
My near term targets is for USD/JPY to fall to 100 and the EUR/USD to rise to 1.55.
However with that in mind, I still think that the US dollar will recover in the second half of the year.
I am a strong believer that we will see a V or at least a U shaped recovery in the US economy that will trigger a dollar recovery and rally in the second half of the year. The Fed’s doing a lot right now and they are being extremely aggressive and this would be especially true if they cut interest rates by another 50 to 75bp this month. Imagine the relief for US consumers and businesses if interest rates came back down towards 1.00 percent. Everyone will be rushing to lock in those rates and use that money for refinancing or capital expenditures. The degree of monetary and fiscal stimulus in the pipeline should lead to a shallow downturn and a swift recovery.
Unlike the past, there is still a lot of money to be spent in the Middle East and Asia. When the US recovers, investors in these countries may sweep in with newfound optimism, which will give the dollar a chance to recover as well.