US fiscal policy disappointment to drive dollar lower?

The U.S. gross domestic product report for the second quarter of 2017 confirmed that economic growth accelerated to a 2.6 percent annualized rate from the first quarter’s sluggish 1.2 percent pace. That should reassure equity investors, but dollar bulls face a number of significant headwinds, including weak inflation, bearish trading technicals and now potential for U.S. fiscal policy disappointment.

It’s been a tough year for the greenback, which has already fallen some 9 percent as measured by the Bloomberg Dollar Spot Index. Add to that the dour outlook issued by the International Monetary Fund, which earlier this week lowered its forecasts for U.S. GDP growth in 2017 to 2.1 percent from 2.3 percent, and cut its outlook for 2018 to 2.1 percent from 2.5 percent.

Source: https://www.bloomberg.com/view/articles/2017-07-28/stronger-growth-can-t-save-dollar-as-policy-risks-rise

USD index testing major support area: 93

US dollar index chart Five year / weekly chart: The US dollar index is testing a major support area of 93. Below that is 84-85. Then 79 comes in to view. Break below 93 could be major. Index is very oversold now, so not surprised to see a pop, and then drop. Momentum could be big on the way down.

Further, in my technical view USD had too much trouble getting much above 100. There’s a solid ceiling in place, while support is breaking down. Lots of potential momentum to the downside given the catalysts: dysfunctional gov’t, enormous debt burden, no signs of Fed effectively tightening or reducing balance sheet in meaningful way, and huge amounts of capital seeking higher returns will likely go to EM and EU.

A stronger dollar means a weaker everything else

As the dollar surges past 97, toward 100, the rest of the market seems to be catching on that this is a risk off signal. Just about every asset class is selling off today as a result. There’s no single catalyst for the stronger dollar. More a myriad of micro-catalysts:

  • The assumption that the EU, UK, Japan and others will continue QE and ZIRP/NIRP as the US Fed raises rates.
  • The notion that the US Fed will raise rates at a faster pace (than they have in the last 3 years of jawboning about it).
  • The structural economic problems in other economies (making ours seem like the least bad of the bunch).
  • Weakness in demand for assets in Japan and Europe.
  • Brexit and the follow-on economic impact on UK.

With all of that in mind, I believe that the current leg of the US dollar rally is becoming problematic for the goals of the US Federal Reserve. Indeed, a strengthening dollar on top of rising US Treasury yields is in a way a de facto tightening. Liquidity tightens and lending/margin speculation decreases.

Should the rally strengthen I believe it will create a significant downside catalyst for a multitude of other asset classes. And there is some small chance that it could spiral in to a deflationary headwind should the situation grow out of the control. My opinion is that the dollar strength could be utilized as an entry point in to beaten up asset classes, especially commodities and emerging markets.

Let’s watch carefully and see where the market takes us from here.

Remember when major currencies used to be stable?

The British pound keeps reminding me that once a reserve currency loses the confidence of its participants, volatility becomes a big problem.

GBP crash

Crashing, as it had post-Brexit and most recently during an HFT-triggered 2 minute flash implosion, shows that even the most liquid markets can become bidless.

This is, in a nutshell, why diversification of investments, including across different asset classes and base currencies, is critical.

Gold’s 2015 performance in various currencies (chart)

The Brazilian Real was walloped and the dollar was clearly a standout winner. Gold’s relative underperformance shows against US dollars that the US dollar is still seen as a safe haven currency.

Until that changes gold will underperform as measured by US dollars. I think we’re closer a that point in time when we see positive price action then we were a year ago, but I can’t say for certain if the markets will agree until stocks move in to a bear market.

As seen in the start of 2016, when stocks were out of favor, gold caught a bid and moved higher each day stocks were sold off. Now that stocks are catching a bid, gold is selling off.

Whether or not 2016 is the year that stocks enter a bear market remains in question. I am inclined to think that we have only seen a prelude for the downside in stocks that could occur this year.

China halts, dollar faults, buyers bolt

Storms are brewing. The wind will carry them from the east to the west. Be careful out there.

Thursday will be another difficult day in stocks and risky credit markets. The dollar is no longer being seen as much of a safe haven. Gold is catching a bid, but for how long?