NARROWING SPREAD BETWEEN TREASURIES AND FOREIGN YIELDS ARE BAD FOR THE DOLLAR -- A STUDY OF QE IMPACT ON DOLLAR DIRECTION -- FALLING DOLLAR MAY HELP STABILIZE COMMODITY PRICES -- BASE METALS HAD A STRONG WEEK -- OIL SERVICE STOCKS ALSO BOUNCED
NARROWING SPREAD BETWEEN GLOBAL YIELDS HURTS THE DOLLAR... The U.S. Dollar has had a bad six months. And things got even worse this week. The driving force between currencies is the relationship between global interest rates. The 10-Year Treasury yield remains higher than foreign developed yields. The problem is that the difference between them is narrowing. The green bars in Chart 1 show the U.S. Dollar Index over the last year. The blue line plots the difference between the 10-Year Treasury yield and the 10-Year German Bund yield. After rising during the fourth quarter, they peaked together in December and have both fallen to the lowest level of the year. That reflects the fact that German yields are rising faster than Treasuries. That was especially true this week when the 10-Year German yield jumped 20 basis points (through Thursday) versus a 12 bps bump in Treasuries. That's good for the euro but bad for the dollar. The 10-Year UK Gilt yield jumped 22 basis points. The red line in Chart 1 shows the difference between Gilt and Treasury yields also narrowing. That boosted the British pound against the dollar. That suggests that dollar weakness is more a reflection of what's happening in foreign markets as foreign central bankers start moving toward normalization of interest rates. The fact that three bank chiefs in Europe, Britain, and Canada suggested that in the same week strongly hints at a coordinated plan to start lifting global rates. The Fed started that process in October 2014. Foreign bankers are just getting started. That means they have a lot of catching up to do. That's bad for the dollar.
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Chart 1
IMPACT OF QE ON THE DOLLAR ... The next chart show the impact that global QE programs have had on the dollar. And are likely to have now. The first three red arrows in Chart 2 show the three bouts of quantitative easing (QE) initiated by the Fed at the end of 2008, November 2010, and September 2012. With the Fed ahead of the rest of the world, those three moves kept the dollar down relative to foreign currencies. Japan started their own QE program in the spring of 2013 (start of Abenomics) and again in October 2014 (which weakened the yen). The Fed ended its QE program in October 2014 (green circle). That helped launch a bull run in the dollar. The ECB launched QE at the start of 2015. That helped boost the dollar against the euro. Since 2014, the dollar has benefited from the fact that foreign central bankers have been in an easing mode while we were starting to tighten. Judging from comments from foreign central bankers this week, and big jumps in foreign yields and currencies, it appears that the U.S. is now losing that yield advantage. That may be signalling a major peak for the dollar. But possibly a bottom in commodities.
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Chart 2
FALLING DOLLAR IS GOOD FOR COMMODITIES ... One of the most consistent intermarket relationships is the tendency for commodity prices and the dollar to trend in opposite directions. Chart 3 shows that every major turning point over the last twenty years in the Reuters/Jefferies CRB Commodity Index (brown bars) has coincided with a major turn in the U.S. Dollar Index (green line) in the opposite direction. That was true in 2002, 2008, 2011, and 2014 (see arrows). Which brings us to 2017. Chart 4 shows commodity prices and the dollar falling together since the start of the year. Based on historical comparisons, that's pretty unusual. So there may be silver lining in the weak dollar. The Fed is hoping for signs of an uptick in inflation. Some of my recent messages have suggested that's unlikely as long as commodity prices are falling. The falling dollar might not be enough to push commodities sharply higher. But it might be enough to put a floor under them. This week's rebound in oil and copper (and shares tied to them) may be a positive step in that direction. The circle in Chart 4 shows commodities gaining this week as the dollar dropped.
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Chart 3
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Chart 4
BASE METALS HAVE A GOOD WEEK -- BUT GOLD DOESN'T ... Commodities tied to agriculture and energy bounced this week. The most impressive rally, however, came in base metals. Chart 5 shows the PowerShares Base Metals ETF (DBB) climbing to the highest level since April. The DBB bounced off its 200-day average at the start of the month. The DBB includes aluminum, copper, and zinc prices. Stocks tied to industrial metals also had a good week. Alumimum stocks gained 6% and copper 2.5%. Steel stocks gained 3%. Oil service stocks gained more than 2%, helping make energy the week's second strongest sector behind financials. Crude oil jumped 7%. Apparently, some traders are starting to nibble at commodity-related assets again. But not gold. Chart 6 shows the Gold SPDR (GLD) losing -1% this week (gold miners fell 2.8%). While gold usually benefits from a falling dollar, it doesn't do well when bond yields are jumping.
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Chart 5
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Chart 6
GLOBAL BANKERS ARE TALKING ABOUT TAKING THE PUNCH BOWL AWAY ... Today's final two charts concern me. Not because they look particularly bearish. But because they've reached serious overbought territory and some indicators are softening. That makes them vulnerable to surprises. The monthly bars in Chart 7 show the S&P 500 trading along its upper 20-month Bollinger Band. That's not usually a problem until the market reaches overbought territory and starts to show some divergences. Which it has. The 14-month RSI line (top of chart) has reached overbought territory over 70 for the first time in three years. I'm also concerned because the S&P 500 appears to be in the fifth wave of its eight-year bull market (see numerals). According to Elliott Wave Theory, bull markets usually have only five waves. [And fifth waves are where negative divergences become more dangerous]. The weekly bars in Chart 8 show the market advance from its early 2016 bottom. Notice the negative divergence between the SPX and its 14-week RSI line from overbought territory over 70 (falling trendline). Its weekly MACD lines (top of chart) are also weakening. Which is why recent comments from central bankers raise the risk level for stocks. The global bull market has been largely supported by unusually accommodative monetary policies. The Fed was the first to end that strategy and has started hiking rates. Foreign central bankers, however, kept QE going which has kept global bond yields (including the U.S.) anchored at historically low levels. Judging from recent comments, they appear to be getting ready to start taking that punch bowl away. When they do, it's usually a sign that a party is nearing an end. That doesn't make me especially bearish right now. But all of these factors combined are enough to make me feel a lot more cautious. [Seasonal note: The market has entered the seasonally weaker between between May and October. July, however, usually experiences a modest summer bounce. I'm more concerned about the period between August and October when more dangerous seasonal tendencies emerge].
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Chart 7
