Four Implications Of A US Dollar Rally

• Two bullish dollar charts
• Several dollar sympathy relationships are likely to reverse

In a couple of September articles on the dollar I suggested that the potential for a short-term rally existed, as bearish sentiment and other indicators appeared to have moved to an extreme. A rally of some kind does appear to be unfolding, though at this point we have to treat it as a counter-cyclical one as the Dollar Index remains well below all of its principal long-term moving averages that define the direction if the primary trend.

It’s important to remember that swings in the dollar’s fortunes do not occur in isolation. They influence a lot of other relationships along the way. I call them “dollar sympathy relationships”.

Two bullish dollar charts

I’ll get into that later, but for now let’s take a look at a couple of bullish dollar charts. Chart 1 compares the Index to my currency diffusion indicator. This one monitors a basket of cross dollar relationships in a positive trend. The arrows show that oversold reversals usually result in a worthwhile short- to intermediate style rally, although the early 2017 signal underscores the difficulty of playing a counter-cyclical advance.

Note that the Index also temporarily dipped below the red breakdown trendline and is now comfortably above it. That whipsaw signal suggests that a rally of above average strength could be in the cards as bearish traders cover shorts or re-position themselves.

Chart 1

Chart 2 is more interesting in that it compares the more broadly based Wisdom Tree Bullish US Dollar fund, the USDU to its Special K, which you can read about here.

Generally speaking, when its possible to observe two trendline violations, one for the Special K and another for the price, this offers reliable signals of an important trend change. Three examples have been flagged with the arrows. The Special K recently violated a seven month down trendline, but the USDU has not. However, the price is extremely close to that line, which is just under $26. If it moves above it, two positive technical developments will follow. First, it will confirm the Special K action of an important reversal. Second, it will also confirm the false breakdown below the solid 2015-17 red trendline. Finally, note that the KST in the bottom window, has just rallied above its 2017 resistance trendline. That’s a very positive sign indeed.

Chart 2

Swings in the dollar’s fortunes affect many markets and relationships but the four most important are:-the ratio between US stocks and the rest of the world, US bonds versus the rest of the world, bond yields and commodity prices. Let’s consider them in turn.

Several dollar sympathy relationships are likely to reverse

Chart 3 compares the Dollar Index to a ratio between the S&P and the Vanguard All World Ex US ETF (SPY/VEU). The ratio is not an exact replica of the Dollar Index, but the broad movements certainly swing in sympathy with the dollar’s fortunes. At this point, the ratio’s short and intermediate KSTs are in a positive mode. This suggests two things. First it adds further evidence to the near-term bullish case for the dollar. Second, the trendline break argues for some kind of US relative strength rally.

Chart 3

Chart 4 shows that since 2015 the dollar’s fortunes have been closely tied to that of the 10-year yield. The arrows flag the consistency of that relationship in the last two years. You can also see that the 10-year has violated a down trend of similar length to that of the dollar.

Chart 4

One problem using the 10-year in isolation is that there was no obvious connection with swings in the dollar prior to 2015. That’s probably because the currency is more influenced by the differential in rates between the US and the rest of the world.

That’s where Chart 5 comes in, as it compares the dollar price of US and international bonds. This is achieved in the form of the ratio between the Barclays Aggregate US Bond Fund and that for International Treasuries (AGG/BWX). Note how this relationship closely reflects movements in the Index prior to 2015. Once again, when the dollar is rising US bonds tend to out- perform and vice versa. The upside breakout in the ratio again supports the bullish dollar case, at least over the short-term.

Chart 5

Swings in the dollar also affect commodity prices, which tend to move inversely with the currency. Please note the emphasis on the word “tend” as sometimes the two move in the same direction. Generally speaking though, it is usually safe to assume that when the dollar is rising it represents a headwind for both commodities and gold. Chart 6 shows this relationship and also indicates that the DB Commodity ETF (DBC) has yet to break above the declining green trendline.

Chart 6

To see what’s likely to happen we need to dig deeper. This time I’ll plot the commodity ETF right side up, so the declining line in this chart appears as a rising one in Chart 7. It shows the probability that the price is in the process of forming a bearish wedge formation. Note how it tried to move above the upper red trendline but failed to hold above it in the form of an exhaustion move. That’s not necessarily the kiss of death, but it does suggest that recent gains are likely to be digested in one form or another, and that means the KST will likely trigger a sell signal.

Chart 7

Chart 8 shows the Bloomberg Commodity ETN (DJP) this series was moving sideways as the DBC was advancing, and has now violated its up trendline. It's KST is already bearish.

Chart 8

Finally, the iPath Crude Oil Total Return ETF (OIL), earlier this week, experienced a very strong outside day, as indicated in the final chart. That too is likely to place downward pressure on the various commodity indexes over the next 5-10 sessions. If so, that would probably allow the KST to roll over and go bearish. A decisive break below the red up trendline, say to $5.25, would likely confirm such a scenario.

Chart 9

Good luck and good charting

Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.