Investors Appreciating the Dollar

In 1944 the dominance of the US Dollar was codified in the Bretton Woods agreement establishing it as the reserve currency of the planet. The Dollar was the natural choice since the world needed finite Gold backed currencies to prevent excess inflation and the US held 75 percent of the worlds gold.  As inflation pressures in the US bubbled up and countries began converting their depreciating dollars to gold, Nixon shut the Gold window by 1973 creating the free floating global currency system we have today. This removed the forced discipline of fixed currencies, letting the debt and inflation genie out of the bottle. With almost two thirds of world reserves held in Dollars today, there is no hint of the our Greenback losing its dominant status for many years, much to the envy of geopolitical rivals Russia and China. 

With our currency reigning supreme amongst central banks, commodity transactions have been priced in Dollars and move inversely to our currency value. Precious metals such as Gold and Silver tend to be sensitive to Dollar trends which is why they have fallen over the past year while the Dollar appreciated. Our thesis this year has been for a US and China trade deal completion to coincide with a a new downtrend in the Dollar and higher prices for precious metals. In the ensuing 6 to 12 months following a trade deal we expect commodity inflation to push our Dollar into the 88 to 93 zone. While we wait for a trade agreement to initiate these new trends – perhaps in the second quarter – the Dollar remains in an uptrend and could work higher into the 98 to 100 zone.  The 95 area is key support.

The Euro comprises 58% of the US Dollar currency basket and just over 20 percent of global central bank reserves. It’s large weighting in the Dollar index means it has the strongest inverse correlation of the major currencies relative to the Greenback.  The Euro value has faded about 10 percent as the Dollar strengthened this past year. Until a China trade deal arrives, there is risk of the Euro falling to support near 110. A break higher above the 116 to 117 resistance zone would turn the long term trend higher. With the Eurozone economies weak relative to the US there has been no reason for fund flows to stop leaving Europe for the safety and yields in the US.

The Australian Dollar (Aussie) is tethered to raw commodities and the Chinese economy. The Aussie will remain weak as long as commodity markets are depressed. Assuming Trump can ink an historic China trade deal and it triggers our expectation for a weaker US Dollar, we foresee the Australian Dollar being one of the best major currency pair beneficiaries of an ensuing surge in commodities. The Australian economy hasn’t experienced a technical recession (two consecutive quarters of economic GDP contraction) in almost 28 years, in large part due to the proximity of their resource based economy to China. Almost a third of Aussie exports end up in China with less than 5 percent heading to the US. For the past 6 years the slowing in China and appreciation of the Dollar have deflated most commodities and suppressed the Aussie. A new trade agreement out of China has the potential to lift China, emerging markets and commodities along with the Aussie. If 2019 support at 70 is broken before a trade deal is signed, the Aussie Dollar has risk down to the 68 to 69 zone, at which level Hedge Funds may reach extreme oversold sentiment triggering new buyers. On the upside we are watching 72 as well as the 73 to 74 resistance zone above which confirms significant uptrends in the Aussie.

The New Zealand Dollar (the Kiwi) is often tethered to the Aussie, thus the outlook  for the two are similar.

Canada has ridden the secular consumption of energy with steady growth and only three recessions over the past 60 years. However, hanging their economic hat on oil and gas rigs entail diversification risk. When the US and most industrialized countries avoided a recession in 2015 to 2016 as Oil fell to $26 a barrel, Canada experienced 7 quarters with no net growth. As Oil fell back from the $70’s to $42 a barrel in the fourth quarter of 2018, Canada once again fell back to an economic contraction during the final 4 months of the year. We don’t need to know anything about Canada’s economy in the first quarter of 2019 to predict it will be an up period as Oil rose by almost 50%. While this is mildly supportive for the Canadian Dollar (the Loonie), the strength of the US Dollar has kept the Canadian in check. When a US and China agreement becomes imminent the Canadian Dollar and Oil will benefit greatly from a weaker US Dollar. The Loonie needs a new up wave in the global economy and Oil to breakout to the upside. A break above the 76.70’s would confirm a major upside reversal in the Canadian and a break of short term support at 74 would target a further pullback to the 73.25 to 73.65 area.

The Swiss Franc (Swissy), created in 1850, has a reputation of stability and safety. The price of Francs have been in a long narrow trading range for most of the past decade, but trending lower over the past 14 months. Hedge Funds have been holding a neutral outlook in their net holdings of the Swissy, requiring a further sell off to reach a clear oversold condition. Like much of Europe, the outlook for the Swiss economy and bond yields are weak relative to the US which encourages repatriation to US Dollar assets away from Switzerland. Currently key resistance is 103 to 104.50, above which the longer trend becomes positive. Until then the downside risk is the major support zone near 97.

The Japanese Yen, created in 1871, is the second largest weighting in the US Dollar index and moves inversely to the Greenback. The Yen has been stuck in a trendless price pattern on the monthly and weekly charts, while modestly lower trend on the daily charts. There is little indication of direction in the Yen basis Hedge Funds that remain neutral to mildly oversold. With the current technical analysis outlook mixed, we look for major support and potential extreme oversold readings to occur should the Yen depreciate to the 87 to 88 support zone, with downside momentum accelerating should prices break 89.30 support. If the US Dollar peaks in the second quarter or whenever a China trade deal becomes imminent, then the Yen should begin to appreciate on a more secular basis in anticipation of an export rebound.

The British Pound Sterling is one of the worlds oldest currencies initiated in the 700’s AD and originally measured as an equivalent of a troy pound of sterling silver. The Pound is a commodity we prefer to punt on forecasting to some degree given the political uncertainty. Brexit (British exit from the European Union) lacks clarity, but our current forecast is for another deadline extension and eventual Soft exit agreement boosting Sterling close to 135 in the second quarter and eventually 138 to 140 if confidence in a Soft exit is high. A Hard Brexit where no agreement with the European Union is reached would severely tarnish Sterling, sending the British pound well under support of 130 with risk to the 125 – 126 support.  

The Mexican economy has existed for decades upon the kindness of it northern neighbor. The US is Mexico’s biggest trading partner by far with huge trade surpluses surpassed only by China. Despite our wealth and their cheap labor, Mexico has a long history of corruption and an inability to manage its economy. Thus the Mexican Peso (MXN) mirrors its failing South American neighbors with a currency in perpetual decline – losing over 80 percent of its value since the early 1990’s. When Mexicans earn Pesos they spend them immediately. When they collect Dollars they hold them like Gold as a store of value. The good news for the Peso is a temporary reprieve from mundane depreciation is due later this year when our Greenback peaks and begins a longer term correction. Assuming our Dollar thesis is correct and commodities rebound with a year of better global growth, the Peso has potential to rally into the 55 to 60 zone. While Hedge Funds are not as important in the Peso given its tiny float, Large Spec funds have bought record net long positions in the currency that normally connote a strong risk of Peso liquidation should their economy and Oil prices weaken. The safer outlook here for investors is to stay on the sidelines until there is a China deal or when the Peso breaks above key resistance at 54 before adopting a Bullish longer term posture.

Emerging market currencies like the Peso have been depressed for years along with their important commodity based economies. While none of these countries have transitioned into functioning democracies to profit from their much younger age demographics compared to Western countries, they are also repressed by the dominance of the US Dollar which deflates their raw export products. The Brazilian Real and virtually all emerging currencies remain near their multi year support, but should become strong investment opportunities when there is an historic trade deal between the US and China.

 

 

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