EURO RALLIES WHILE DOLLAR WEAKENS -- A REVIEW OF FLORIDA CURRENCY CHARTS -- SHIFT FROM ASIAN DEFLATION TO INFLATION -- BEWARE A RISING YUAN
WE DON'T GET ANY RESPECT ... Modified to correct the language, that familiar refrain was until recently the mantra of the Euro. The beleaguered currency, however, has perked up and begun to rally. We noted in a previous article at the start of March (March 01, 2006) the change in mood towards the Euro. At the time, we identified a bullish "morning star" formation (green circle). That was a valid buy signal which began from the 1.1850 level. The daily candlesticks in Chart 1 show the improvement since then. Chart 1 also tells us a few other things. First, the Euro is nearing a test of its January high at 123.18. Secondly, that the Euro has also reached its upper Bollinger Band which suggests a short-term overbought condition. Combined with the proximity to the January high, it does suggest the likelihood of a short-term pullback or consolidation. Wider bands are also forecasting more volatility in the Euro. That can be seen more clearly in the "Bollinger Band Width line (BB)" at the bottom of Chart 1. A rising BB line means more volatility and more price movement. In this case, the movement appears to be upward. An eventual close over the January high (which appears likely) would be a bullish sign for the Euro and a bearish sign for the dollar.
Chart 1
DOLLAR INDEX BREAKS 200-DAY LINE ... When the Euro rises, the dollar usually falls. That was certainly the case yesterday when the U.S. Dollar Index closed decisively below its 200-day moving average. The USD is clearly on the defensive and appears headed toward its January low at 87.83. Adding to the dollar selling is the perception that the Fed is nearing the end of its tightening cycle while the European Central Bank and the Bank of Japan have just begun their tightening cycles. Rising commodity prices have also been hinting at a weaker dollar since they usually trend in opposite directions. The outperformance by foreign stock ETFs has also been hinting at a weaker U.S. currency. [Note: The analysis of the Euro was provided by Jeanette Schwarz Young who is a trader on the New York Board of Trade].
Chart 2
WEEKEND CURRENCY CHARTS ... I mentioned last Thursday that I was giving a speech over the weekend at the Forex Trading Expo in Ft. Lauderdale, Florida. Although all the charts I used were taken from previous Market Messages, I thought you might like seeing them put together in a more organized speech format. You can view the fifteen slides by clicking on (Ft. Lauderdale currency charts ). [The dates on the slides are when they were originally published in the Market Messages]. Although the headlines on the charts are self-explanatory, I have a few comments to add. The bullet points in Slide 2 summarize the traditional intermarket relationships. The key one is that a falling dollar is bullish for commodities. Another is that rising commodity prices are usually bearish for bonds. It's taken awhile for that to happen, but bond prices are finally starting to fall (as bond yields rise). Bonds and stocks usually trend in the same direction except during deflation. With Japanese deflation ending, the historical link between bond and stock prices should start to resurface. One caveat to that is that bond prices usually peak several months before stock prices do. That suggests that stocks could run into problems during the second half of the year. Finally, rising commodity prices help emerging markets. Rising global interest rates, however, may start to diminish investor appetite for those riskier markets.
SHIFTING FROM ASIAN DEFLATION TO INFLATION ... Slide 13 includes two charts that were published on this site on September 28 of last year. The chart to the left shows the close correlation between rising gold prices and Japan iShares. The chart to the right of Slide 13 shows the close connection between the Japanese stock market (orange line) and 5-year T-note yields. The chart shows that both bottomed together in 2003 and have been rising together since then. Both charts appear to support the headline that "New Japanese Leadership Signals Shift to Global Inflation". The bullet points in Slide 14 summarize the main Intermarket Principles. The last two are the most important. A global view of markets is important. [Even the Fed has started to talk about foreign influences on U.S. interest rates]. The last bullet point simply repeats my oft-repeated claim that the shift from Asian deflation to Asian inflation is a driving force behind rising commodity prices, rising inflation, and rising global interest rates.
BEWARE THE RISING YUAN ... Another global factor behind yesterday's dollar drop was a comment out of China calling for a higher yuan and the reduction of China's holdings of U.S. debt. Our government has been calling for a higher yuan as well. I ended my Florida speech with a warning of what a higher yuan could mean. For one thing, it would mean a weaker dollar. That would have the effect of raising the prices of imported goods especially those from China. That would boost U.S. inflation. The Chinese buy huge amounts of dollars to keep the yuan from rising. They invest those dollars in U.S. Treasuries. That has helped keep bond yields down. A higher yuan would require less dollar buying by the Chinese and less buying of U.S. Treasuries. That would boost long-term rates which in time could hurt the U.S. stock market and the economy. "Be careful what we wish for".
