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posted on 04 February 2016

How To React To The Big Dollar Move

by Jim Welsh

Special Report from Macro Tides 03 February 2016

In the January 26, issue of Macro Tides I thought the odds that the U.S. and the global economy would warrant 8 rate hikes within two years was virtually zero, or about as likely as the Cubs winning the World Series in 2016.

"On the surface it seems so obvious that the dollar will continue to rise. The Fed is going to raise rates, while the ECB pursues more accommodation, and the Bank of Japan and People's Bank of China contemplate more easing. This is why the majority of global investors are bullish the dollar and already positioned for the Dollar to rise and already short the Euro."

This is why I thought the Dollar index was poised for a modest decline in coming weeks, which would be positive for risk assets in general. Since the Euro comprises 57.6% of the Dollar index, a close above 1.1020 by the Euro, would induce a bout of short covering which could easily lift the Euro to 1.1275 to 1.1400.

Today the Euro exploded higher from yesterday's close of 1.0927, reaching a high of 1.1156 before closing at 1.114. This move was caused in part by the Euro climbing above the series of lower highs since mid-December, which sparked the aforementioned short covering. The Dollar index fell out of bed after it broke below the rising trend line from its mid-December low. This part of these moves was based on simple chart analysis. Fundamentally, investors have begun to believe the Fed will not raise interest when they meet in March.

This was reinforced by comments this morning by William Dudley, president of the New York Federal Reserve who said:

"One thing I think we can say with more confidence is that financial conditions are considerably tighter than they were at the time of the December meeting. The weakening outlook for the global economy and any further strengthening of the dollar could have "significant consequences" for the health of the U.S. economy."

The irony of this statement is that financial conditions were obviously tightening before the Fed raised the federal funds rate at its December meeting.

The key question for the financial markets is how long will the correction in the dollar last and how deep will it go. As I concluded in the January 26 Macro Tides,

"If the Dollar index does decline modestly in coming weeks, it should be positive for risk assets in general."

Here's what to watch for in the Dollar and various markets.


If the Dollar index trades below 96.45 and closes below 96.60, the correction is likely to last longer and carry the Dollar index below 94.00. If today's shakeout is no more than a short covering pop for the Euro, the Dollar should hold above 96.60. I think a deeper pullback in the Dollar is the more likely outcome. The U.S. ended 2015 on a weak note, as GDP grew just .7% in the fourth quarter and the market turmoil in January wasn't a positive. A weaker employment report on Friday will go far in confirming this outlook. If the employment report comes in strong, and the dollar has held above 96.45, the rally in risk assets is likely to be abbreviated.

Treasury Bonds

There is a decent chance the yield on the 10-year Treasury bond made an important low today based on its chart pattern. Between September 2013 and May 2015, the yield remained in the downward channel as noted by the two red trend lines. In early June, the yield broke out above the top red line, and has remained above the channel, except for a number of brief excursions below the top red line. Today was one of those times. From a high of 2.489% on June 26, 2015 the yield dropped .584% to a low of 1.905% on August 24, 2015.

The yield rose until November 9, 2015 when it reached 2.377%. A decline equal to the .584% drop between June and last August would target a low of 1.793%. Today's low was 1.794%, before rising to 1.881% at the close. As long as the 10-year Treasury is above the upper red trend line, the odds favor an increase in the yield, potentially to 2.632%. It seems completely counter intuitive that yields could go up as it becomes more apparent the Fed is not raising rates in March, nor likely to increase them 4 times in 2016. To the extent that yields have been coming down in the face of a slowing global economy and the potential the Fed would make a bigger mistake by raising rates again, clarity that they won't be making this mistake may cause the bid for Treasury bonds to fade. Plus, sentiment is very bullish about the Treasury bonds, so the market could be caught off guard should yields begin to climb.

Gold and Gold Stocks

On December 30, I recommended gold and gold stocks. Since December 31, the gold ETF (GLD) is up 7.6%, the gold stock ETF (GDX) is up 11.9%, and the S&P has lost -6.4%. In the January 26 Macro Tides I recommended selling 25% of GLD if it traded up to 111.00 and 25% of GDX at 14.98. Today GDX traded up to $15.35 and closed on the high. Selling another 25% of the position at $16.05 and raising the stop from $13.40 to $13.60 seems prudent. If it spikes to $16.60 I would sell another 25%. Sometime in 2016, GDX has the potential to trade above $20.00, so let that be a guide in terms of how aggressive you want to trade.

I would still sell 25% of GLD if it trades up to 111.00 and raise the stop to $104.50 if GLD trades above $110.00. It would be an intermediate positive if gold is able to close above $1,160, since it would suggest any pullback would hold above $1,080.


In the February 2 Weekly Technical Review I said:

"Even if the market is ultimately destined to go higher in coming weeks, the odds favor a pullback to 1870 - 1890, before a subsequent rally occurs."

Today the S&P traded down to 1872 before reversing and closing at 1912. Today's low at 1872 reinforces the importance of the 1870 level. If the S&P closes below 1870, a decline to the low of 1812 or lower should quickly follow. The S&P has the potential to rally to 1955 - 1978, which is 61.8% and 78.6% of the 135 point rally off the January 20 low of 1812. As I noted in the January 26 issue of Macro Tides,

"The most important point is not how much the market rebounds in the short term, but that another decline is coming. My guess is the S&P will drop to 1750 and potentially 1600 before this bear market is over."

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