Looking on the bright side ..... a comforting take on things for those still long the US Dollar.

Tuesday 5th April 2016

  

Looking on the bright side ..... a comforting take on things for those still long the US Dollar.

"Dollar Bulls Cling to History for Redemption After Wrong-Way Bet" , Bloomberg Markets

Actually, this article was first posted on Bloomberg on Sunday night (updated yesterday) and discusses a topic that we and anyone else with an interest in any market monitor on a daily basis, and bang on about almost as frequently. Doesn't sound as though this piece will be at the cutting edge, does it? Fortunately, we don't have to make that claim so no apologies. The value of, and prospects for, the US Dollar is pivotal to just about every economy and the markets that trade within them so any new slant is welcome, even if this particular one might sound to some like clutching at straws.

The long-term USD rally that essentially started in July 2011 was widely expected to continue into 2016, driven by the divergence in the prospects for interest rates in the US compared to elsewhere ..... US rates to go higher, everywhere else to go lower. Perfectly logical of course but not to put too fine a point on it, at the end of the first quarter that trade has come a cropper. The trade-weighted UD Dollar Index is down well over 4% since Jan 1st, and the greenback itself is down an eye-watering 8.4% against the Japanese Yen. But beyond the safe-haven status that has boosted the Yen and to some extent the Euro, why should that be the case? Aren't US rates are still going to go up? And rates in Japan, Eurozone etc have already moved lower, haven't they?  Surely the divergence trade is still on?

The fact is that the new cautious (doveish) approach from the US Fed prompted by those oft-quoted "global headwinds" has seen them rein back expectations to two rate hikes this year, rather than the four they predicted in December -- and the markets incidentally are considerably less hawkish than than. At the same time, ECB boss Mario Draghi has indicated a reluctance to push short-term rates ever lower whilst the Bank of Japan has refused to go further into negative territory even in the face of very poor data. So yes, divergence is still happening but not nearly on the scale that was expected .... which is to say the reality has come as a huge disappointment to a market already long US dollars. Hence, a large proportion of loss-making long dollar positions have been dumped.

But the Bloomberg article suggests that if you are of an historical, technical bent you might get some comfort from a look at a long-term US Dollar Index chart. It shows that since the break-up of the fixed exchange rate Bretton Woods system in 1971 there have been two major long-term dollar rallies before this latest one. The first began in August 1979 when under Chairman Paul Volcker the Fed embarked on a strategy of aggressive monetary tightening. The rally peaked in February 1985, and was comprehensively reversed after central banks agreed an intervention plan to do so  --  yes, our old friend the Plaza Accord.  The second began in May 1995 when a strongly performing US economy saw new Treasury Secretary Robert Rubin instigate a tightening regime that prompted a dollar rally that lasted until early 2002.

The point being made is that those rallies lasted an average of 74 months and posted gains of 54% and 41% respectively. If you buy into the idea that past performance can indeed give us a clue as to the future, then the current rally still has some way to run both in terms of time and percentage gain. At its peak in January the index had gained about 39%  and of course is considerably lower now.

Hang on a minute, we hear you say, you can't just ignore what's happened this quarter. What if it's not just a setback but the end of the rally? A very fair question ..... and the counter from dollar bulls is that recent action is very similar to that of 1998 in the middle of the last bull-run, when the Fed cut interest rates to deal with the fallout from the Asian crisis. The dollar took a considerable breather until rates were raised again and the rally resumed for another three years or more. The Fed getting all doveish over concerns over global financial markets? Ring any bells?

It's just one view, of course. Plenty of those who were long dollars at the start of the year have been blown out. Plenty more have revised their targets at the very least. But there are still a good many convinced that the rally will reassert itself. They may be right, but for their sakes we hope that their pockets will have been deep enough to stay in the game in the meantime.