FM Wealth Management News Letter
The US dollar (UUP) has gained back nearly of the early 2018 losses and is now trading in positive territory for the year.
This upward trend has piled pressure on those who shorted the dollar, in fact every short position from mid-January is now in the red.
As we can see there are a lot of them. According to Bank Of America, short positioning is near a seven-year high. The dollar downtrend throughout 2017 was such a one-way affair it invited traders to keep selling, as further declines looked a sure thing. Those that were bearish on the Dollar would have felt confident and complacent right up until the end of April when the bearish consolidation pattern broke the wrong way.
This complacency soon turned to panic as dollar bears soon realized their shorts weren’t such a sure thing after all. They were asking themselves what had changed and of course he natural thing is to look for reasons for the move.
What Changed
The break from the early 2018 range came right before the April 26th European Central Bank meeting. The ECB essentially did not say anything at all on policy, so you can’t say it was a major catalyst. You could try to make the point that the ECB is trying to buy time and monetary policy divergence is back in focus, but this is nothing new. US data has strengthened this year while Eurozone data has swung the other way and noticeably softened.
ING reported recently, that at last week’s ECB meeting, the head of the ECB, Mario Draghi, pointed to temporary factors like the weather and strikes to partly explain the weakness in recent economic data. He mentioned earlier that the largest trade war impact on the Eurozone economy could come through the confidence channel. First Quarter data suggests that some of the weaker confidence has translated to lower growth for now. Even though early survey data for the Second Quarter has stabilized, there is not much that indicates a bounce back.
Contrast this with the US Federal Reserves’ minutes from March.
“The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong.”
Therefore if one central bank is trying to find explanations for weakness and the other is highlighting strength, policy divergence is understandable. Britain is also seeing a dip in inflation and what looked like a near-certain rate hike in May is now anything but certain.
The apparent re-calibration with yields is seen as another factor in recent dollar strength. It is quite amusing to us how the divergence with rate differentials had analysts scratching their heads for most of last year as the dollar fell despite rising rates, and just when they thought they’d found an explanation (twin deficits), rate differentials start to matter again and the dollar has started to rise alongside rates.
Is it that US rates hit a magic number where the dollar suddenly became more appealing?
That could be but we track it back to the raft of Federal Reserve speakers in the week of April 16th.
The hot topic that week was the flattening of the yield curve, which was reported by ING when San Francisco Fed President (from June NY Fed president) John Williams admitted that an inverted yield curve has in the past been a “powerful signal of recessions”, but he doesn’t “see the signs yet of an inverted yield curve”. He believes that there is more of an inflation threat than Bullard, which will mean longer dated bond yields will move higher, but that the curve will continue to flatten which is “totally normal” in his view.
Fed Governor Quarles agreed yesterday by saying that he was not viewing the current flattening of the yield curve as a particular signal towards pending recession. Just like Williams, he believes the longer end of the bond market is lagging behind and will respond.
Well, the longer end did respond, and pretty much right away with a sharp rally in the 10-year, which steepened the yield curve. Not by much, but enough to break its immediate downtrend.
This breakout just happened to be when the dollar rally accelerated and 10-year yields seemed to matter once more.
Unfortunately there is not much historical evidence if a flattening or steepening yield curve is better for the dollar as there are so many other considerations. But its fair to say the recent rally in the 10-year has had a positive effect.
So Where Do We Go From Here
In early February we warned of a reversal from around 88 and proposed the path below based on a repeating (but smaller) technical pattern.
What’s interesting is the reversal pattern unfolding now is very similar to the one proposed but much smaller than expected.
We are looking at structure, not scale. These comparisons are helpful as it maps a fairly clear path up to 94 and then back down if the pattern continues to repeat.
Your Takeaway
The rally in the US dollar has surprised many especially as it makes new yearly highs. The two main reasons behind the rally are central bank policy divergence and the Fed’s comments on the yield curve, which have been particularly influential. Based on previous Dollar reversal patterns, this rally should pause but continue generally higher to the 94 area before losing steam again.
This upward trend has piled pressure on those who shorted the dollar, in fact every short position from mid-January is now in the red.
As we can see there are a lot of them. According to Bank Of America, short positioning is near a seven-year high. The dollar downtrend throughout 2017 was such a one-way affair it invited traders to keep selling, as further declines looked a sure thing. Those that were bearish on the Dollar would have felt confident and complacent right up until the end of April when the bearish consolidation pattern broke the wrong way.
This complacency soon turned to panic as dollar bears soon realized their shorts weren’t such a sure thing after all. They were asking themselves what had changed and of course he natural thing is to look for reasons for the move.
What Changed
The break from the early 2018 range came right before the April 26th European Central Bank meeting. The ECB essentially did not say anything at all on policy, so you can’t say it was a major catalyst. You could try to make the point that the ECB is trying to buy time and monetary policy divergence is back in focus, but this is nothing new. US data has strengthened this year while Eurozone data has swung the other way and noticeably softened.
ING reported recently, that at last week’s ECB meeting, the head of the ECB, Mario Draghi, pointed to temporary factors like the weather and strikes to partly explain the weakness in recent economic data. He mentioned earlier that the largest trade war impact on the Eurozone economy could come through the confidence channel. First Quarter data suggests that some of the weaker confidence has translated to lower growth for now. Even though early survey data for the Second Quarter has stabilized, there is not much that indicates a bounce back.
Contrast this with the US Federal Reserves’ minutes from March.
“The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong.”
Therefore if one central bank is trying to find explanations for weakness and the other is highlighting strength, policy divergence is understandable. Britain is also seeing a dip in inflation and what looked like a near-certain rate hike in May is now anything but certain.
The apparent re-calibration with yields is seen as another factor in recent dollar strength. It is quite amusing to us how the divergence with rate differentials had analysts scratching their heads for most of last year as the dollar fell despite rising rates, and just when they thought they’d found an explanation (twin deficits), rate differentials start to matter again and the dollar has started to rise alongside rates.
Is it that US rates hit a magic number where the dollar suddenly became more appealing?
That could be but we track it back to the raft of Federal Reserve speakers in the week of April 16th.
The hot topic that week was the flattening of the yield curve, which was reported by ING when San Francisco Fed President (from June NY Fed president) John Williams admitted that an inverted yield curve has in the past been a “powerful signal of recessions”, but he doesn’t “see the signs yet of an inverted yield curve”. He believes that there is more of an inflation threat than Bullard, which will mean longer dated bond yields will move higher, but that the curve will continue to flatten which is “totally normal” in his view.
Fed Governor Quarles agreed yesterday by saying that he was not viewing the current flattening of the yield curve as a particular signal towards pending recession. Just like Williams, he believes the longer end of the bond market is lagging behind and will respond.
Well, the longer end did respond, and pretty much right away with a sharp rally in the 10-year, which steepened the yield curve. Not by much, but enough to break its immediate downtrend.
This breakout just happened to be when the dollar rally accelerated and 10-year yields seemed to matter once more.
Unfortunately there is not much historical evidence if a flattening or steepening yield curve is better for the dollar as there are so many other considerations. But its fair to say the recent rally in the 10-year has had a positive effect.
So Where Do We Go From Here
In early February we warned of a reversal from around 88 and proposed the path below based on a repeating (but smaller) technical pattern.
What’s interesting is the reversal pattern unfolding now is very similar to the one proposed but much smaller than expected.
We are looking at structure, not scale. These comparisons are helpful as it maps a fairly clear path up to 94 and then back down if the pattern continues to repeat.
Your Takeaway
The rally in the US dollar has surprised many especially as it makes new yearly highs. The two main reasons behind the rally are central bank policy divergence and the Fed’s comments on the yield curve, which have been particularly influential. Based on previous Dollar reversal patterns, this rally should pause but continue generally higher to the 94 area before losing steam again.
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