It Is All About The Fed & The Dollar!

Topics Covered

• It is all about the Federal Reserve and the US Dollar direction

Overview

The selling pressure has stopped for now as risk assets and safe havens both move in sideways patterns. It seems that the S&P 500, Crude Oil and Gold are now in a rebound rally of some type, however rallies in certain risk assets have been much stronger than in others. On the other hand, safe haven assets like US Dollar and Long Bond have paused their vertical rise and have entered corrective mode.

It seems we are entering a period of mean reversion but the bottom line still remains the same: investors have been selling risk due to possibility of a disorderly default in Eurozone, triggered by Greece as the first domino, followed by Spain and Italy contagion effect. At the same time, Asia and especially China is slowing down meaningfully. At present, bearish trades still remain crowded, but not as much as they were at the start of the month.

Economic Data

Nothing new to report. Refer to the side menu for previous articles.

Equity Markets

Nothing new to report. Refer to the side menu for previous articles.

Bond Markets

Nothing new to report. Refer to the side menu for previous articles.

Currency Markets

Here in Asia, we are awaiting the FOMC just as much as traders in Europe or US are. Instead of going out for a drink after work with a few mates (which sometimes gets out of hand), majority of us will be glued to our seats, awaiting Bernanke's speech, which might (or might not) change the direction of the US Dollar and therefore a lot of other asset classes in the global macro world.

Consider the chart above. US Dollar bull market started in early May 2011, two months before QE 2 program ended. It has since been trending in a slow upward motivation of higher highs and higher lows - your typical uptrend or bull market according to the Dow Theory. Furthermore, simple and basic upward trends usually resemble two basic features:

1. Majority of the time price remains above the 200 MA
2. Price climbs by respecting an uptrend line, using it as support

As much as I am a US Dollar bear (and have been for a very long time on fundamental basis), I have to admit and conceive that we are most likely not yet at the final top. Why do I say that? Well, consider the second chart above. Over the last several years, US Dollar rallies have ended with panic spikes that trigger "major catalysts". Currently, we have not yet seen a price spike, nor have we seen a "major catalyst". Pretty simple in theory, but not necessarily correct.

Therefore, technically we can so far conclude that the US Dollar trend is bullish and that we have not seen any major panic price spikes that tend to be of terminal nature. In case one is wondering what a terminal movement within a trend is - it is a vertical rise based on strong emotions of either greed or panic (in this case panic) that is not sustainable. These occurred in 2008 and 2010 on the second chart above.

Let us move along and see how the Dollar is doing globally. Because the US Dollar Index is constructed in such a way that it only follows six major currencies (all of them Developed Economies) and heavily weighted towards the Euro, I consider it a flawed tool. It is pretty much similar to following an index of only 6 stocks heavily weighted towards Apple instead of S&P 500 as a whole. Therefore, I much rather follow broader measures like the Trade Weighted Index or even better, US Dollar breadth across the whole world including Commodity Exporter and Emerging Market currencies. * Note: precious metals like Gold, Silver and Platinum are also counted as global currencies.

So what I did is construct my own US Dollar Breadth Barometer, seen in the table above.Looking at performance of the US Dollar across the globe, in the table above. it tracks the technical strength of the US Dollar against European currencies, Commodity currencies, Eastern European currencies, Asian currencies, BRIC currencies and other GEM currencies from Latin America and Africa. Looking at the current data, we can conclude two simple points:

1. US Dollar has been weak in recent weeks as it has experienced a correction after such a powerful performance in May. Dollar price is above its 5 MA against only 11% of global currencies and above its 20 MA against only 18% of global currencies.
2. US Dollar has been very strong in both the medium and long term trends. Dollar price is up above its 50 MA, 100 MA & 200 MA against at least 70% of global currencies and in some cases almost 100%. That signals very strong breadth and not just Euro strength only.

Moving along let us look at some Emerging Market currencies vs the US Dollar, but this time in a chart format since the start of 2008, when the global debt crisis started to intensify.

First of all, Eastern Europe has been the most affected area since the global crisis started. Currencies within this area of the world have experienced major volatile swings in bullish and bearish directions. Markets would panic and the Dollar would spike, which would be followed by policy reaction where the Dollar would sink very fast again. So if this seems to be the template, what is the current price telling us?

The US Dollar has been in an uptrend against majority of these currencies since at least early May of 2011. While the bull market trend is ageing and most likely closer to the end, we have still not seen a major price spike, similar to that of Lehman '08 event or the Greek Bailout '10. What makes me think it will happen again? There is just about 100% certainty that Greece will eventually default, and it seems the Dollar spike could occur as that event plays out in up-and-coming months or quarters.

Commodity Exporter currencies resemble similar pattern since 2008, as can be seen in the chart above. While the S&P 500 has made new higher highs in April 2012, no major global currency has confirmed this outcome. All global currencies including BRIC currencies, that are considered as risk assets, have failed to exceed their peak of May and July 2011. In other words, the US Dollar bull market continues to create a risk off environment. So how close are we to a top?

That question is very difficult to answer. However, it is definitely possible to argue that there are way too many US Dollar bulls as of late. It was only a few weeks ago that the Dollar Public Opinion hit a new record in optimism. That means, more bulls than at any time during Lehman Brothers panic of late 2008 and Greek Panic of middle 2010.

It is also definitely possible to argue that, sentiment survey's aside, investors are actually putting their money where their mouth is and have now racked up record bullish bets on the US Dollar via COT futures positioning. It is more than 3 standard deviations away from the mean, which I would consider "extremely and insanely bullish".

So how could we summarise the current US Dollar conditions?

Today a meeting of FOMC heads, including Ben "money printer" Bernanke, Janet "negative interest rates" Yellen, William "Dovish" Dudley and Charles "I agree to all & any type of money printing" Evans will all be voting in favour of some type of action. Furthermore, they have an easy setup and a huge chance to squeeze the "living lights" out majority of market participants who are record long the Dollar. However, the question is will they? While anything could happen, my view is they most likely will not engage into a major program. On the other hand, the situation in Europe is getting out of hand with Spain and Italy in crosshairs again. The crisis is intensifying into its final stage and things are now getting serious. Can kicking is just about done.

Like I stated at the beginning of the article, over the last several years, US Dollar rallies have ended during panic spikes that trigger "major catalysts". Maybe this time around, a major catalyst will be a Greek default, which in my mind is just abut a 100% portability sometime in the next few months or quarters. Therefore, the Dollar could correct in the short term on Fed action, but the final spike might still be in the cards as Eurozone crisis intensifies. Finally, maybe Ben might have something to say about all this, but if we do not get a strong QE program right here, the US Dollar bull market might not be over yet.

Finally, as a disclosure, I am positioned towards major Dollar squeeze with a large core Silver position (for awhile now) and few shorter term long trades from Agriculture & Energy commodities.

Commodity Markets

Nothing new to report. Refer to the side menu for previous articles.

Credit Markets

Nothing new to report. Refer to the side menu for previous articles.

Trading Dairy Updates

• I have purchased some small exposure towards Brent Crude Oil (BNO) and Mosaic Fertiliser (MOS) earlier in the week. I also purchased some Silver (SLV) too, but for now it seems to be acting a lot weaker than others, so I have closed it at BE point.
• I am also still holding onto core Silver position from late December 2011 bottom at $26. Strong PMs fundamentals going forward and huge net long positions in the US Dollar are some of the main reasons.
• Risk assets still remain on my watch list for some shorter term bullish rebound trades. These include Brent Crude (BNO), Commodity Indices (GCC / RJI), Precious Metals (GLD, SLV, CEF, PSLV, etc) and Agriculture (RJA / MOS). I believe commodities are very oversold right now and should bounce soon. I have not done anything and will not do anything until I hear from the Fed.
• I am waiting for an equity & currency market rebound first, before engaging into some shorts, as I believe a global bear market is here. I will compile a list of assets to short as we get closer to the US election.