The power of the dollar trend has been almost shocking in the last week. It’s almost as if EUR/USD parity is a singularity whose gravitational pull is drawing the trend towards an inevitable confrontation. But observing the longer term chart for EUR/USD I can’t escape the feeling that parity will be tough to reach at the first attempt. There are huge support levels as evidenced by the downward sloping trend-lines (which are also channel supports) in the illustration below. Based on these support lines I am looking at the 1.0170 – 1.0270 zone to halt the current move. That’s still some way to go, but the positive divergence I have noticed in recent weeks is a warning that this could happen.
One of the reasons why the Great Depression was as traumatic as it was, was because of the trade wars that ensued. 80 years on, mankind is wiser (or at least we like to think we are), but we may look back in another 80 years and remark that history may not exactly repeat itself but it most certainly rhymes (kudos to Mark Twain), because even if there has been a slight retreat from increasingly open global markets it’s been very mild, but there is another phenomenon which has gathered pace since the global financial crisis – Currency Wars. Last night South Korea cut interest rates to a record low of 1.75%. It was not expected. Interestingly, if this was intended to weaken the currency it had the exact opposite effect. In fact the technicals suggest an ‘outside day’, and we could see some Korean won appreciation in the next few sessions. Time will tell. But this is the least of it, South Korea is merely the latest country cutting policy rates, a list that includes: Denmark, Switzerland, China, India, Thailand and Australia to name but a few, and not forgetting the ECB’s plans to implement quantitative easing. I believe the Russians and Brazilians have hiked interest rates, but not many more have done so. Generally the countries which have cut rates have used deflation fears as the rationale for their actions. Something which I’ve argued for some time will be a transient phenomenon, the primary motivation in my view has been to maintain competitive currencies by causing them to weaken. When you realise that both Russian and Brazilian currencies have been amongst the weakest this year and rising inflation has been a threat it’s easy to understand why their actions have been so out of step with the rest of the global community. But here’s the thing… currencies are a relative instrument, if you weaken your currency you’re doing so relative to others. One can easily appreciate the absurdity of everyone trying to weaken their currencies at the same time. It’s impossible. This is what makes the rise of the dollar such an obvious consequence. The Federal Reserve in focussing on the domestic economy of the United States and have absolutely no reason to desire a weaker currency. Their very indifference has guaranteed, and will continue to guarantee dollar strength, because almost everyone else wants their currency weaker!
The last few days have seen equity markets focus on these currency issues, and European stocks have outperformed US stocks. Over time I would expect more domestically focussed or currency insensitive stocks in the United States to outperform the more internationally exposed stocks. The speed at which this rebalance occurs will be the determining factor for whether US stocks can continue to new highs from here or not. As I’ve mentioned before though, the stronger the US dollar becomes the lower the probability of hikes in the United States. I believe the market expects the Federal Reserve to change the wording at their next meeting to signal that rate rises are possible, but I am increasingly wondering if at the same time they make comments about the pace of the strengthening of the U.S dollar. If their level of concern at the might of the greenback increases we could see a sharp reversal in this current move. I don’t say this as an expectation that they will do so, but it’s important after the price action we’ve seen to acknowledge that at some point currency markets do become a more important part of the equation for the U.S central bank. For now there still appears to be scope for further appreciation of the U.S dollar, at least until we get to the bottom of the channel in the chart above.
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