Still All About The Dollar

It is Thursday morning the 19th of April during Asian trade. It has been an interesting week so far. Looking at the business cycle - Russian, Japanese & US IP disappointed all around, while the US retail sales showed positive growth. Indian Central Bank cut interest rates for the first time since 2009, while inflation in the UK was above expectations, giving the Pound some strength. German investor sentiment (ZEW) was positive for the third straight month.

Important economic data releases for the rest of the week include:

• Spanish 2 Yr & 10 Yr Bond auctions
• French 2 Yr, 3 Yr & 5 Yr Bond auctions
• US Initial Jobless Claims
• Philadelphia Fed Manufacturing
• German Ifo Business Climate
• UK Retail Sales & Canadian CPI

Global manufacturing business cycle is in the 4th year of the expansion mode and continuously prepped up by global central bank intervention. However, European countries are being a drag on global GDP, with contracting PMIs and mild recessions. Confidence has taken a hit on the continent. The on-going debt crisis, harsh austerity and increase in taxes has completely removed growth from the current expansion in the EU business cycle. The stock market in Europe is no higher than where it was in August of last year. Spanish IBEX has declined below the previous major bottom of March 2009, while Italy is not too far away either.

Meanwhile, the rest of the word is still growing, with US holding its own too. The Restaurant Performance Index is a great barometer of US consumer spending (more than two thirds of the economy) and it shows no signs of a slowdown or recession. It is also not showing any signs that the current Gasoline prices are impacting the US consumer. Retail Sector ETF (XRT) seems to be confirming this outlook at the present time. 

I think all eyes will be on the EU Bond auctions during European trade today with both Spain and France selling short, medium and long term debt. The US Dollar triangle, as seen in the chart above, is now running out of room and will soon break in either direction (great news for traders). This could be a perfect catalyst to trigger a major movement. The uptrend which started in May 2011 has now lasted for almost 12 months with higher lows, but at the same time since January 2012, the Dollar has failed to progress upward in any meaningful manner and continues to make lower highs as well. 

Regarding the triangle price above, a trader emailed me yesterday and told me that currency investors are torn between focusing towards further Fed easing on the one hand and EU debt problems on the other. I disagreed. I agree that the price action itself is actually focusing on those two issues, hence the triangle, but the traders and investors are herding in one direction only.

According to the data I follow, and as shown in the chart above, investors are happily holding the largest US Dollar net long position since June 2010 at over 2 standard deviations away from the mean. It is pure US Dollar love affair. Furthermore, being long the Dollar has become a favourite trade of some large pension funds, who are usually the last guys to join the party. 

Financial Times reported that PIMCO shifted gears in recent weeks to bet the dollar will rally against some major currencies. Standard Life Investments Ltd is buying the dollar and selling the euro, reversing last year’s strategy (note: where were they last year?). Franklin Templeton Investments also has thrown some of its $700 billion behind the greenback. They join Jim O’Neill, chairman of Goldman Sachs Asset Management, who also is calling for a stronger dollar. Nouriel Roubini has expressed that the Euro would have to decline to parity to give the Europeans their competitive edge once more, while John Taylor of FX Concepts, is super bearish on the Euro. 

To summarise, long Dollar is a major consensus trade right now. Having said that, do keep in mind that, despite high bullish sentiment, the US Dollar could move higher out of the triangle in coming days or weeks. I have a feeling that any move higher will be short lived and most likely a head fake from which a major reversal will occur.

While the love affair with the Dollar is quite obvious, the same cannot be said about commodities. The chart above shows that CRB Index is currently near its support of 295 and at the same time it is oversold as its trading 2SDs away from its 50 day MA. Equal weighted CRB Index known as Continuous Commodity Index, is now down for the 8th straight week.

Sentiment on majority of the commodities remains very negative (opposite of the US Dollar). Daily Sentiment Index on Coffee stands at only 7% bulls, on Sugar at 9% bulls, on Cotton at 13% bulls and finally on Wheat at only 15% bulls. Public Opinion thanks to SentimenTrader website is quite low on commodities like Copper, Silver, Platinum, Cattle, Coffee, Lean Hogs, Corn, Wheat, Cotton, Sugar and finally at super bearish extremes on Natural Gas (which is probably at a lifetime buying opportunity). In the chart above, we can see that the overall CRB Index sentiment is also very low. Are we close to the bottom or will commodities break down even lower? I guess it rests in the hands of the Dollars movements in coming weeks.

Super bears over at Elliot Wave International think that Silver looks "heavy" around here and could drop "rapidly" towards $26 support in coming days and weeks. While I am not so sure if we will drop towards $26 per ounce, I think a rapid fall of 5% towards $30 per ounce in coming days could be possible, especially if it is caused by the weak Euro / strong Dollar combination.

Strong Dollar is not the only issue weighting on commodity prices right now either. Chinese GDP continues to slow too, as we can see in the chart above. Every single GDP quarter since early 2010 has been slower than the previous. At the same time Shanghai Composite has been in a bear market since early 2010 as well, reflecting the Chinese slowdown. However, from the contrarian point of view, the market action shows we have recently refused to make a lower low and are moving towards the 200 day MA with a potential break out. If the bullish outcome in the Chinese stocks was to occur in 2012, contrary to majority expecting a hard landing, it would also prop up commodity prices. Shanghai Composite & CRB Index have high correlation to one another.

Moving towards equities, the recent survey of hedge fund managers by Merrill Lynch, showed that equity positions were cut while cash positions were increased substantially (chart above), despite a minimal correction. US equities remain the most favourite of all the regions for global managers, while the Eurozone risks are biggest worry going forward. This doesn't give us any edge to be quite honest, as global fund managers seem to be quite neutral at present, unlike their extreme bullish positioning in Feb 2011 or their extreme bearish positioning August 2011.

Chris Puplava's recent equity market breadth article puts forward evidence that the current price action in the S&P 500 was just a correction. As we can see in the table above, top two sectors that are making the most 52 week new highs have been cyclicals, which are very economically sensitive. If the economy was about to slow down meaningfully, the markets action would be negative in the process of discounting this event. Furthermore, if is very interesting to note that commodity related sectors seem to be struggling the most in the current environment. This is obviously due to lower commodity prices (CRB chart above) and would improve very quickly if the US Dollar was to break down.

Moving onto the Bond market, I think we are slowing building a top in price / bottom in yields around these levels. Whenever money supply levels grow year over year, inflation in the cycle tends to rise and interest rate expectations move upward. On top of that, we can say that more bond purchases will definitely trigger yields to rise as well. Technically, the 200 day MA has finally caught up to the super sharp move we saw in August of last year. Furthermore, Long Bond is now up six weeks in the row, which is quite overbought. A failed new high above 145 for the Treasury market might signal a first major LOWER HIGH in coming days and weeks and than a break below the 200 day moving average is possible.

Finally, credit markets still give me no signals in either US nor Europe that anything major is on horizon. As we can see in the chart above Euro Dollar Basis Swaps over 3 months continue to improve since December of 2011 while the EU Libor OIS rate keeps falling. iTraxx CDS Index has risen as stocks have corrected, which is to be expected, but one sign of worry is that banks are still hoarding all the LTRO money at the ECB overnight deposit facilities. This fear amongst European banks lets us know that a real systemic problem is still alive and well within the EU banking sector and eventually the chickens will come home to roost. For the time being that is not a worry, but when we see Financial sector heavily under-performing S&P 500, the issue will most likely become front page once again.

Summary
It is all still about the US Dollar triangle. There has been a lot of calmness in the currency markets for the last few days as we await a catalyst to trigger a Dollar move in either direction. Watching the investor demand for Spanish debt could be critical for the way rest of the week plays out. Next weeks Fed meeting could also be a major market mover too.

Sentiment on the Dollar is way too bullish for me to chase prices higher, so instead I will be waiting for commodities to bottom (whenever that is) and slowly start to buy in. As already discussed before, with decently strong breadth and improving credit markets, I don't expect an equity bear market right now. Instead, there is a possibility bonds yields might rise soon.