DOLLAR TURNS LOWER AS EURO AND YEN RISE -- A WEAKER DOLLAR WOULD BOOST COMMODITIES AND FOREIGN ETFS
DOLLAR INDEX BREAKS 200-DAY AVERAGE ... The Dollar Index has taken a turn for the worst this past week. The daily bars in Chart 1 (through Thursday) show the USD falling below its March low and its 200-day moving average. The daily MACD lines are also in negative alignment. That suggests the likelihood for a further decline in the Dollar Index to its January low at 87.83. At the same time, the Euro and yen are rallying. Chart 2 shows the Euro as a near mirror image of Chart 1. The Euro has risen to the highest level since January and is back above its 200-day line. It's next upside objective is the January high at 123. Its MACD lines are pointing up. Chart 3 shows an improving Japanese yen. It has cleared its 50-day line and is challenging its March high. It may be headed toward its 200-day line and its January high near 88. Yesterday's benign inflation report -- combined with weak housing numbers -- raised hopes that the Fed may be closer to ending its rate hikes. At the same time, the ECB and Japan may be just starting their tightening cycle. The narrowing in the spread between U.S. and foreign rates is negative for the dollar and bullish for the Euro and the yen. A softer dollar would carry a lot of intermarket implications.
Chart 1
Chart 2
Chart 3
A WEAKER DOLLAR SHOULD BOOST COMMODITIES ... The most obvious result of a weaker dollar would be rising commodity prices and stocks tied to those commodities. The next two charts show a normal inverse relationship between the Dollar Index (Chart 4) and the CRB Index (Chart 5). The November peak in the dollar near 92 coincided with a bottom in the CRB. The January trough in the dollar coincided with a downturn in the CRB. The dollar's fall beneath its 200-day line this week increases the odds that the CRB Index will survive its test of that long-term support line. That would be supportive for basic materials, gold, and energy stocks. Foreign stocks too.
Chart 4
Chart 5
WEAKER DOLLAR HELPS FOREIGN ETFS ... A falling dollar benefits foreign stocks in two ways. First, it encourages foreign investments by Americans. That's because American investors benefit when foreign stocks are rising with their local currencies. They get the stock gains and the currency gains. That effect is seen more directly in foreign stock Exchange Traded Funds. Since foreign ETFs are traded here in the states, they are quoted in U.S. dollars. Foreign ETFs rise faster when the dollar is dropping and the foreign currency is rising. Chart 6 shows the effect. The green line is the Dollar Index over the last ten months. The other line is a ratio of the EAFE iShares (EFA) divided by the S&P 500 SPDRs. [EAFE stands for Europe Australia and Far East). Notice that when the dollar falls (last July to September and last November to January), the ratio rises. When the dollar rises, (October to November) the ratio falls. The January-March bounce in the dollar caused a pullback in the ratio. This week, a falling dollar is pushing the EFA:SPY ratio near a new high. The chart simply demonstrates that foreign ETFs do better than the U.S. when the dollar is falling -- as it's doing now.
Chart 6
IMPACT OF RATES ON THE DOLLAR... The direction of the dollar is based on many factors. The main one is the direction of U.S. interest rates. Another is the relationship of U.S. rates to foreign rates. In this article, I'm going to show how U.S. rates effect the dollar. The green line in Chart 7 is the Dollar Index. The dark line is the 2-year T-note yield. I'm using a shorter maturity because it's more sensitive to Fed rate moves. Notice the tendency for both lines to trend in the same direction. They bottomed together last September, peaked together in November, and turned up in January. This past week, both have started to drop. That shows that the dollar benefits when rates are rising and weakens when rates start to dip. The drop in the dollar has been much more severe than the pullback in rates this month. Up until recently, U.S. rates were the only factor impacting the dollar because global rates stayed flat. Over the last month, however, the ECB raised rates a second time and the Japanese are starting to tighten. That means that the dollar is being hurt not only by ideas that short-term U.S. rates may be near a peak, but by rising foreign rates.
Chart 7
Chart 8
THE DOLLAR FOLLOWS RATES ... Chart 8 shows how the direction of the U.S. Dollar Index has followed the direction of U.S. rates over the last eight years. The green line is the Dollar Index while the weekly bars are the 2-year T-note yield. Rates started dropping sharply at the start of 2001 as the Fed eased aggressively to combat a recession and fears of deflation. The Dollar Index (green line) peaked at the start of 2001 and started to fall a year later. Short-term rates bottomed in mid-2003 but didn't start rising significantly until mid-2004 when the Fed started its current tightening policy. The dollar bottomed at the start of 2005 which was six months after the Fed started to raise short-term rates. Chart 8 shows that the dollar tends to follow the direction of U.S. rates. I've overlaid a 9-week RSI oscillator on the 2-year T-note yield. It's showing some negative divergence at the moment (blue arrow) which may be suggesting that shorter maturities are due for a pullback. That means that the Fed could be ending its tightening cycle just as foreign central banks are starting theirs.
HEAD AND SHOULDERS DOLLAR BOTTOM?... It's possible that the current dollar pullback is part of a large basing pattern of the head and shoulders variety. A case can be made that the Dollar Index formed a left shoulder at the start of 2004 and a head at the start of 2005. The fourth quarter peak near 92 stopped right at the spring 2004 peak. That allows for a neckline to be drawn over those two peaks. That interpretation allows for a drop in the USD to last summer's low near 86 as part of a possible right shoulder. That would be a fifty percent retracement of the 2005 price advance and would be a logical spot for new buying to emerge. Any severe break of last summer's low, however, would call into question the "head and shoulders" interpretation. On the upside, the Dollar Index would have to clear the "neckline" near 92 to confirm a long-term bullish breakout. Neither of those two events appears likely over the short-run. Even if the "head and shoulders" interpretation proves correct further out in time, the short-term picture for the dollar is looking weaker.
Chart 9
HAPPY ST. PATRICK'S DAY ...
