Last week brought us pretty much the ideal scenario for those
long of risk assets right now: an accommodative ECB; a FOMC
announcing that it was not altering its QE / bond-buying program
for the foreseeable future; a slight positive surprise on the
Chinese manufacturing PMI; and a US non-farm payrolls number that
wasn't too hot, wasn't too cold, but just right. In addition, there
were other data points, like a better ISM manufacturing number and
a decrease in weekly jobless claims, that served to keep the bears
on the defensive.
While some frustrated (bearish) market analysts point to the tepid
nature of this economic recovery as a non-confirmation or bearish
divergence of the equity markets' bull run, they fail to understand
or acknowledge that the economy and the markets actually have very
little direct correlation historically. One of the few
relationships that can be shown relatively consistently over time
is that the markets are a forecasting mechanism and not a
confirming mechanism. As such, the equity markets should have and
have had little meaningful reaction to most backward-looking
numbers. The one exception to that statement would be, as I've
shown previously, the 4-week average of weekly jobless claims - and
that average has been trickling lower recently (favoring the risk
So, as a result of the news flow and central bank actions recently,
traders have seen equities breaking to new highs and bond yields
range-bound (to the delight of the Fed). Commodities have been
mixed, with gold and silver rebounding, crude oil range-bound
between $100 and $110, copper catching a bid off of China's upside
surprise (PMI last week), and agricultural commodities under major
What about currencies? What are the biggest, most liquid markets in
the world telling us right now about the dollar, yen, and euro?
US rates and the DXY were whipped around last week but
remain below resistance.
All that data and news early last week served to push interest
rates and the US Dollar Index up to resistance at 2.723% and 82.42,
respectively. Friday, however, the US non-farms payroll data came
in slightly below expectations, and both the interest rates and the
US dollar reversed course and headed lower rapidly (away from
So what happens next for the dollar? Will the US bond vigilantes
succeed in pushing rates up through resistance and confirming that
a new secular bull market in rates (bear market in bond prices) is
underway? Or will the Fed succeed in keeping rates contained -
thereby continuing to allow for asset prices to rise in what
appears to be a no / low inflation environment?
In the first scenario, the DXY would likely react bullishly to the
vigilantes' success in crushing bonds / boosting rates. A breakout
above not only the 82.42 level but up through the July peak at
84.75 would almost certainly occur if rates broke out.
In the second scenario, where the Fed succeeds in keeping rates
contained, one would intuitively think that the DXY also would
remain subdued. However, unlike rates, when looking at the US
Dollar Index, we have to consider what may be happening with the
countries and currencies with whom the US dollar trades.
Euro and Yen Outlook
The two biggest components of the DXY are Europe and Japan. The
current narrative out of Europe seems to be that things are
improving off of a very low base economically, which is giving the
euro a temporary boost. There appears to be room for the euro's
rally to continue before key resistance is tested at just above
The narrative out of Japan, though, is less clear. One week, we
hear rumors of Japan employing more hawkish fiscal and monetary
policies to straighten out their balance sheet, thereby boosting
the yen. Another week, we might hear about Japan's Abenomics
continuing to remain in effect, thereby keeping a lid on the yen.
All of these fundamental cross-currents are enough to make traders'
heads spin, which is why so many are now watching the technicals so
carefully. Based on the chart below, it appears like the yen could
/ should continue to correct higher in the short term - perhaps
until 1.07 is tested on the upside.
Technical Outlook for the Greenback
So, with the help of the short-term upside that is likely to
continue in the euro and yen, I am calling for some more downside
to occur in the greenback in the short term. This selling should
take the DXY down to 80.71 - 81.13 from 81.96 currently. Once the
DXY establishes a low in the short term, my call is for a very
sizeable rally in the DXY to occur, coinciding with a resumption in
bearish action in the euro and eventually in the yen. This
anticipated rally in the DXY will likely create new multi-year
highs and may test the June 2010 peak at 88.71.
Summing It All Up
So, switching from technical to fundamental to wrap things up, the
Fed may succeed in keeping rates under wraps for a bit longer, but
(if I am correct in my forecasts) they may lose control of rates
and the US dollar sooner rather than later. I must note that that
this outlook will be invalidated by a close below 80.71 for the DXY
- so traders would be wise to earmark that level when constructing
their investing / trading plans.
For my part, I will be watching for good entry points in:
ProShares Ultra Short 20+ Year Treasury ETF
(NYSEARCA:TBT): right now, $75.18 looks like the best shot to get
Power Shares US Dollar Bull
(NYSEARCA:UUP): looking at an $21.95 entry if all goes according
ProShares Ultra Short Euro ETF
(NYSEARCA:EUO): looking at an $18.18 entry; and
ProShares UltraShort Yen ETF
(NYSEARCA:YCS): the entry here doesn't come until $54.52.
Interestingly, there seems to be enough room to the entry point
for YCS that it's bullish counterpart
ProShares Ultra Yen ETF
(NYSEARCA:YCL) may be a good short-term trade at current