POWERSHARES DOLLAR BULLISH ETF BREAKS OUT TO THE UPSIDE -- DOLLAR RALLY IS SUPPORTED BY WIDE PREMIUM OF U.S. BOND YIELDS OVER FOREIGN YIELDS -- STRONGER DOLLAR FAVORS U.S. OVER FOREIGN STOCKS -- EMERGING CURRENCIES TEST MAJOR SUPPORT
POWERSHARES U.S. DOLLAR BULLISH ETF BREAKS OUT TO THE UPSIDE ... The U.S. dollar rally continues. The line on top of Chart 1 shows the U.S. Dollar Cash Index (USD) trading at the highest level in four years. The main chart shows the PowerShares US Dollar Bullish ETF (UUP) breaking out to the highest level since the end of 2010. [Athough the UUP ETF has lagged behind the cash $USD, the correlation between the two is virtually identical]. Today's breakout in the UUP simply confirms the bullish action in the USD. Previous messages have expressed my view that the dollar is still in the early stages of major bull market that could last for years. That carries important implication for global money flows. A stronger dollar will keep downward pressure on commodities, and precious metals in particular. For another, it makes U.S. bonds and stocks more attractive for foreign investors. A stronger dollar reflects the fact that the U.S. economy is the strongest in the world. The fact that U.S. interest rates are higher than in other developed markets, and expected to rise faster, is probably the biggest force behind the global trend into U.S. markets.
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Chart 1
BOND YIELDS ARE MUCH HIGHER THAN GERMANY AND JAPAN ... Currency trends are mostly about interest rates. Higher interest rates imply stronger economic growth. That's the case with the dollar. The four lines Chart 2 compare the 10-Year Government yields in the U.S., UK, Germany, and Japan. The chart shows that the U.S. is the highest of the four. The gap between the U.S. and UK is relatively small (2.37% versus 2.26%). The gap between Germany and Japan is much bigger. That's because the eurozone and Japan are in the middle of a monetary easing cycle in an attempt to battle deflation. Compared to Germany and Japan, U.S. Treasuries offer much higher yields which makes them more attractive. That drives money into bonds and the U.S. dollar. That also explains why the dollar has been rising against sterling, the euro, and yen.
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Chart 2
PREMIUM OF U.S. YIELDS SUPPORTS DOLLAR... The best way to see the impact of interest rates between countries is by looking at their spreads. The blue line in Chart 4 shows the spread between U.S. 10 year and German yields to be at 1.53%. That's the highest spread in at least five years. Not surprisingly, that huge premium of U.S. over German yields has pushed the dollar to a two-year high against the Euro. Expectations also matter. While the Fed ended its QE bond buying program last month (and higher short-term rates expected during 2016), the eurozone is expected to ease monetary policy even further to combat deflation. The favors the dollar over the Euro. The orange line in Chart 4 shows the spread between higher U.S. 10-year yields and Japan turning up at the end of 2012 and currently at 1.89%. That was the year that the Japanese embarked on a massive quantitative easing program to combat deflation. The green area in Chart 4 shows the dollar turning up against the yen during 2012, and now trading at a seven-year high. The Japanese "doubled down" on their version of QE last week which also weakened the yen against the dollar. Divergent monetary policies among developed nations should continue to support a higher dollar.
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Chart 3
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Chart 4
RISING DOLLAR FAVORS U.S. STOCKS... It should come as no surprise to read that a rising U.S. dollar also favors U.S. over foreign stocks. The black line in Chart 5 plots a ratio of the S&P 500 divided by the Vanguard All-World ex-USA ETF (VEU). The green area represents the trend of the U.S. Dollar Index. They generally trend in the same direction. Dollar drops during 2009 and 2010 shows U.S. underperformance (a falling ratio). Since the dollar turned up during 2011, the S&P has outperformed foreign stocks (a rising ratio). The S&P/foreign stock ratio is now at the highest level since 2007 as the USD nears a challenge of its 2009/2010 highs. Since September 2011, the S&P outpaced foreign stocks by a margin of 66% to 22% (while the Dollar Index rose 18%).
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Chart 5
EMERGING CURRENCIES TEST SUPPORT... Emerging markets are especially vulnerable to a rising dollar. The green line in Chart 6 shows the Wisdom Tree Emerging Currency ETF (CEW) falling sharply since July and in the process of threatening chart support along lows of the last three years. [The CEW includes emerging currencies in Latin America (including Brazil), South Africa, emerging Europe (including Russia) and Asia (including China). A decisive violation of that support line could undermine emerging markets stocks (red bars) which are positively correlated to their currencies. Some of the weaker currencies are from commodity exporters like Brazil, Russia, and South Africa. Their stock markets may also suffer from continued weakness in commodities.
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Chart 6
IT'S GOOD TO SEE A GENERAL LEADING...AND MICROSOFT ... The Dow Industrials hit a new record high today (along with the Dow Transports), which keeps the market uptrend intact. What's a little surprising is that the strongest percentage gainer in the Dow is General Electric. The daily bars in Chart 7 show GE climbing nearly 2% today to the highest level in nearly two months. It has also exceeded a resistance line drawn over its July/September highs. GE has been a Dow laggard all year. Today's leadership is a welcome change. Another Dow leader was Microsoft. The monthly bars in Chart 8 show MSFT closing at a new record after recently clearing its 2000 peak near 43. Its relative strength ratio (top of chart) is nearing an upside breakout as well.
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Chart 7
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Chart 8
S&P 500 HITS NEW RECORD -- SMALL CAPS ADVANCE ... Chart 9 shows the S&P 500 trading at a new record high which resumes its major uptrend. Chart 10 shows the Russell 2000 Small Cap Index having broken a resistance line drawn over its July/September highs. That appears to have ended the downside correction that started during the spring. With the midterm election behind us, cyclical and seasonal trends have turned positive for U.S. stocks.
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Chart 9
