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24 Mar 2016
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 Thursday 24 March 2016

PM Bulletin: Dollar correlations

 

 

The direction of the US dollar has a great influence on other financial instruments. The trouble is that there’s really no hard and fast rule that says, for instance, the dollar is strengthening so that means equities will go up (or down) as well, particularly over the short-term. However, there are some striking correlations which leap out when studying longer-term charts. Some obvious ones involve the greenback and dollar-denominated commodities. For instance, when gold hit its all-time high (in nominal terms, that is – not inflation-adjusted) in August 2011, the US Dollar Index was trading near multi-year lows. The Dollar Index subsequently rallied around 35% until early December last year. Over the same period gold lost 45%. Since the end of last year the dollar basket is down around 4% while gold is up 16%.

Another obvious example is the greenback and oil. In the summer of 2014 the Dollar Index broke below 79.00 while Brent was trading around $110 per barrel. In January this year the Index was hovering just below 100 when oil hit $27. So the dollar rose 26% while Brent crude lost 75% of its value over the same period. Since then oil has bounced while the dollar has slipped back.

Here’s a daily chart of the EURUSD. I put the Andrews’ Pitchfork on earlier this year when the euro’s post-ECB low on 3rd December became significant. What this shows is the shallowest of uptrends for the euro, and corresponding dollar weakness. But the currency pair really is struggling to push higher as it hasn’t even made it to the median line of the indicator.


   
The US has had to put up with a stronger dollar for quite a while now. This is positive when it comes to imports but negative as far as US multinationals are concerned. A strong dollar hurts US corporate overseas sales and translates into lower earnings. But it has wider implications too. After all, low crude prices are causing all kinds of problems for oil producers around the world, not to mention those financial institutions who lent money to US shale producers when oil was over $80 per barrel. As we have seen, oil tends to rise when the greenback declines. A lower dollar would also take pressure off emerging market economies where financial institutions have taken out large dollar-denominated debts over the last five years or so. But it wouldn’t be so good for the Euro zone or Japan who are both desperate to keep their currencies competitive to boost exports and inflation.

On a fundamental level we should be seeing the dollar strengthen against both the euro and yen. After all, the BOJ and ECB have recently loosened monetary policy while the Federal Reserve has begun to raise rates. Not only that but despite last week’s dovish FOMC statement and projections, four regional Federal Reserve presidents have just called for a rate hike next month. How on earth can the dollar not strengthen in this environment of divergent central bank policies? Well it may do. But there are a number of problems stemming from all these years of central bank activism: the BOJ’s actions are seen as ineffective (note the rally in the yen following the adoption of negative interest rates), the ECB may have reached the limits of monetary tightening (as indicated by Mario Draghi) and nobody really believes the Fed anymore. So the US dollar can be really useful in forecasting whether other markets will rise or fall. But predicting where the greenback is going is proving more difficult than ever.

Disclaimer:

Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Tagged: Bulletin PM

Category: PM Bulletin


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