WHY THE DOLLAR COULD WEAKEN IN 2020 -- SPREAD OVER FOREIGN YIELDS HAS NARROWED -- STRONGER FOREIGN STOCKS BOOST LOCAL CURRENCIES -- CANADIAN DOLLAR RISES WITH COMMODITIES -- EM CURRENCIES ARE TURNING UP

WHY A LOWER DOLLAR...Yesterday's message suggested that commodity prices may be bottoming; which could lead to a better 2020 for the first time in years.   Part of that analysis, however, was based on expectations for a lower dollar.  That's because a falling dollar is usually necessary for commodity markets to move higher.  The last paragraph in yesterday's message explained some reasons why the next year could see a weaker U.S currency.  Today's message will elaborate on some of them.  The first has to do with the narrowing spread between Treasuries and foreign bond yields.  Over the last several years, the spread between higher-yielding Treasury bonds and lower foreign bond yields supported a higher dollar.   That spread was caused mainly by a more hawkish Fed which raised interest rates while the rest of the world kept bond yields negative.  Over the last year, however, the Fed lowered rates three times and assumed a more dovish stance.   That narrowed the spread between U.S. and foreign yields.  That's normally negative for the dollar.

YIELD SPREAD NARROWS... Chart 1 plots the spread between the 10-Year Treasury yield and similar maturities for German bunds (blue line) and British gilts (red line).  Both lines peaked at the end of 2018, and have fallen throughout 2019.  That's the biggest drop in years.  The reason for the drop is the steeper decline in Treasury yields over the past year.   According to Bloomberg, the 10-Year Treasury yield has dropped 89 basis points over the last year.  By comparison, British and German bond yields have fallen 55 and 47 bps respectively.   Over that same time span, the 10-year Canadian yield fell only 40 bps boosting its currency (more on that later).   While Japanese yields were unchanged.   The fact that foreign yields fell less than the US is normally supportive to their local currencies.

STRONGER FOREIGN CURRENCIES... Four of the six foreign currencies in the USD gained against the dollar over the last year -- the Canadian Dollar, British pound, Japanese yen, and Swiss franc.  Over the last three months, five have risen against the dollar -- the pound, Swedish krona, euro, Swiss franc, and Canadian Dollar.  Only the more defensive yen lost ground.  The krona's recent gain was the result of the Swedish central bank raising its short-term rate out of negative territory for the first time in years.  And may have signaled that other foreign central bankers may start doing the same.   That would be further supportive of their local currencies.  And bad for the dollar.  Foreign currencies of countries that export commodities are having an even stronger year.

CANADIAN DOLLAR AND COMMODITIES ARE CLOSELY LINKED...The monthly bars in Chart 2 compare the Canadian Dollar (green bars) to the Reuters/Jefferies CRB Index of 19 commodity prices (brown bars).   If you're having trouble telling them apart, there's a good reason.   Since Canada is one of the world's biggest exporters of commodities, its currency is closely tied to the direction of commodity prices.   The chart shows both falling together between 2011 and 2015 (as the U.S. dollar rose).  Both bottomed together at the start of 2016 and have been moving sideways together since then.  And both may be trying to bottom together.  The U.S. dollar meanwhile has been dropping for the last three years, which is also supportive to the loonie and commodity prices.

$CDW AND CRB INDEX MAY BE BOTTOMING TOGETHER...The daily bars in Chart 3 compare the CRB Commodity Index (upper box) to the Canadian Dollar in the lower box.  And they both appear to be bottoming together.  The upper box shows the Reuters/Jefferies CRB Index having formed a potential "double bottom" between last December and this August (see circles).   In addition, the CRB has risen to the highest level in eight months; and is nearing a test of its April high.   A close above its spring high would signal that a bottom has been completed.

RISING LOONIE... The daily bars in the lower box in Chart 3 shows the Canadian Dollar forming a bullish pattern of "rising bottoms" throughout the year (see rising trendline).  And it's nearing a test of a falling trendline drawn over its July/October peaks.  A close over that resistance line would pave the way for a challenge of its July peak.  It would take a close over that summer peak to signal a major bottom.  But it appears headed in that direction.  Because they're closely linked, a bottom in one would most likely signal a bottom in the other.  And both would be bad for the U.S. dollar.

FOREIGN STOCKS TURN UP... Another factor that could work against the dollar is   the recent upturn in foreign stocks.  The blue weekly bars in Chart 4 show the MSCI All Country World Index ex US iShares (ACWX) achieving an upside breakout during October, and trading at the highest level since early 2018.  That rally includes foreign developed and emerging markets.   The Stoxx Europe 600 Index recently hit a new record.  And Emerging Markets iShares (EEM) have reached an eighteen month high.   EM currencies are also rising.

RISING STOCKS BOOST CURRENCIES... The green bars in the upper box in Chart 4 show the WisdomTree Emerging Currency Fund (CEW) nearing a test of its July high.  A close above that barrier would constitute a bullish breakout.  Why rising foreign stocks are also bullish for local currencies is because both are symptomatic of growing optimism on the global economy.  And in order for American investors to diversify their stock holdings into foreign markets (which appears likely next year), they have to buy foreign currencies as well.  That means selling U.S. dollars.

MONTHLY DOLLAR CHART LOOKS TOPPY... Ultimately, it always comes down to looking at a chart.   So let's do that.  The monthly bars in Chart 5 plot the U.S. Dollar Index over the last fifteen years.  They show the major bottom formed between 2008 and 2011; followed by a major uptrend between 2014 and 2016.  The chart, however, shows the USD peaking at the start of 2017; and in a declining trend since then.  In addition, its 14-month RSI line (top box) has been in decline for the last five years.  Monthly MACD lines (middle box) also peaked at the start of 2016.   After a feeble rebound over the last two years, the two lines may be about to turn negative again.   All of which suggest that the U.S. dollar may no longer be the world's strongest currency as we enter a new year.  That's not necessarily a bad thing.

BENEFITS OF WEAKER DOLLAR... A weaker dollar would boost commodity markets, and stocks tied to them.  And countries that export commodities.  A weaker dollar could also help large U.S. multinational stocks that derive a lot of revenue from foreign markets by boosting exports.  Stronger foreign currencies make them more likely to buy from us.  That's especially true of China which is the world's biggest buyer of commodities.   Recent firming in the Chinese yuan should make those purchases more affordable.  Which could help make commodities one of next year's success stories.