US dollar index rally stalling, long term trend still down

With all of the fervor over the US dollar index rallying close to 100, a reality check is in order.  According to financial media reports the Euro is collapsing, gold is a barbarous relic that’s lust its luster, oil is falling and the commodity complex itself is imploding.  Readers of this blog may remember that on November 1st of 2014 I wrote about the possibility that such a situation may play out in 2015.

Opportunities may exist in battered markets

Sentiment for other major currencies, energy, precious and non-precious metals could not be much worse than it is now.  Cautious contrarian investors may find opportunities in the extreme negative sentiment. Certainly many natural resources companies have much more attractive valuations now than they did several years ago.  Commodities themselves may also offer more value at these price levels than they did in previous years.  Both as a hedge against inflation and a bet that resource consumption will increase in years to come.

Meanwhile US dollar trend followers may pile on to what appears to be a massive multi-year rally in the US dollar index or short other currencies, commodities and similar assets.  There already exists an enormous amount of speculative betting on the dollar surging higher and other dollar priced commodities and foreign currencies tumbling.  This positioning leads me to believe that we may be closer to a high in the US dollar rally than a base to move higher from.

united-states-currencyThus far the US dollar index on a long term technical basis appears to have made a series of lower highs and lower lows stretching back to the rally in the mid-1980s (see above chart) which began as a result of massive interest rate increases by the US Federal Reserve.  In order to break this downtrend the index would have to rally beyond 120 and sustain itself there.  Only then would I feel that the US dollar has decisively entered an uptrend. That has not happened yet.

The range bound US dollar index

As of the last 10 years we find the US dollar index trading within a range between 72 and 100 (see chart below) which may continue for some time if there isn’t an outside catalyst.  Ultimately I believe the US dollar index is headed for a lower low when the current rally stalls further and then reverses lower.

10yUSD

One must remember that the US dollar index is a trade weighted currency basket that measures the dollar vs. the Euro, Yen, Pound Sterling and does not necessarily directly reflect the purchasing power of the US dollar other than when buying these currencies.  In addition, the US dollar index has enjoyed its current rally largely on expectations of a widening interest rate differential between the US Federal Reserve and other central banks.

Will the September hike come to fruition? Is it meaningful?

The Federal Reserve has repeatedly delayed its much anticipated interest rate hike, setting expectations that such an event may occur this September — and only if economic data fits their ever moving target.  Given the mix of economic data (both good and bad), combined with the backdrop of a significantly weaker Euro and the US dollar beginning to impact multinational companies earnings, I would be surprised if the Federal Reserve set its sights on a heightening cycle.  Perhaps a few increases to placate the financial media.  But a significant normalization of interest rates would likely have catastrophic effects on multiple asset markets, including mortgages, bonds, stocks and interbank financing.

Fed and interest rates thru 2009Up until 2008 the Federal Reserve largely followed the US Treasury 3 month bill rate — rather than vice versa. This meant that interest policy was apparently largely set by the 90-day Treasury Bill market.  See the chart above for a visualization of this trend.

Where there was once rate guidance there exists only volatility

Below you will find a chart of the 3 month Treasury bill rate graphed from 2000 to present.  In that chart one can see that the same dynamic may no longer exist. That is to say that the 3 month Treasury bill rate is extremely volatile and has been since 2008.  Is this an unintended consequence of quantitative easing and zero interest rate policy?  Is the Federal Reserve now without guidance from this critical interest rate setting market?  Or is the paradigm shift one where the Federal Reserve will now lead where the markets once did?

IRX-2000Much as the rate heightening cycle in 2004-2007 set off a powder keg of insolvencies related to highly leveraged speculative bets imploding, I believe any similar rate heightening cycle this time around will have equally disruptivbe, if not worse, consequences. But it’s anyone’s guess at this point.  As you can see we are largely in uncharted territory.

Caution! Market crash could be imminent

With growing uncertainty surrounding the European debt crisis, and the contagion spreading to much larger sovereigns, such as Italy, we now see risk aversion back on the table.  US markets are down over 3%, the headlines seem to be getting progressively worse and many fear that the situation could deteriorate much further — giving up much of the gains achieved in October.

Growing concern as market whipsaws

This kind of volatility, both up and down, is historically an indicator of very large market moves.  With the bias largely negative, it seems that a market crash could be coming if no resolution is found for the EU debt implosion.  Alternatively, should a large scale bailout ($2T+) occur, we could see a significant rally, especially within precious metals spot prices and miners.

For investors and traders, this type of price action is stressful.  Seeing fluctuations of multiple percentage points in indices and nearly 10% in stocks can cause forced position liquidation because of stop loss orders being triggered.  For traders, who generally capitalize on multi-day moves rather than moves within a single day, this type of action can cause significant losses should one be caught on the wrong side of the market action.  High frequency trading machines may capture gains, but are not providing liquidity or improving market efficiency, especially during periods of intense market moves.  Instead, evidence seems to be growing that the machine-based traders are making the market less stable and more prone to large price swings.

World view deteriorates

Global markets plunged as well, with Italy down over 9%, Poland down nearly 9%, Germany down over 7% and other European markets leading weakness as stock prices bleed, especially within the financial sector.  The lackadaisical response out of the EU, ECB and IMF leadership seems to be draining confidence and sparking fear in the markets.

US banks have hundreds of billions of dollars worth of exposure to European sovereign debt, banks and other related instruments.  Many have written credit default swaps, a form of insurance that has no capital reserve (see AIG implosion circa 2008) against European debt, exposing them to significant risks should the EU situation worsen.

Broken bonds from backwards economies

Many Western countries now face the prospect of sovereign debt problems, as their economies continue to slow, while investors fear that they will not be able to pay back the debt.  The United States is no exception, as its official debt reaches 100% of GDP, and by some estimates, their total outstanding unfunded liabilities have reached $75 trillion.

Japan has a 200% debt-to-GDP ratio, which is only made possible by the fact that most of their debt is held by Japanese banks and pensioners, but the situation there is deteriorating with growing political and economic instability.  Even China is no exception, as their economy is slowing down and the yield curve on Chinese debt has inverted for the first time — causing serious concern for those that felt China would lead the world out of recession.

The coming crisis

What happens next is not clear, but what is evident is that the world is changing.  Slowing economic growth, the bursting of the largest credit bubble in history, significant deterioration in debt-driven consumption and resource depletion all leads to a potential crisis.  All of the new debt that has been created to attempt to stem the last debt crisis has only exacerbated the underlying structural economic problems we are facing.  Papering over large amounts of fraud within the financial system and ignoring the peril of main street has divided the Western world.  Growing civil unrest and lack of available employment, especially for the young, has created the potential for large scale disruptions (think of the “Occupy” movement, but on a global scale with a significant percentage of the population participating).

I feel that unless we start seeing accountability within the financial sector and governments of the world, prosecution of the enormous fraud, transparency within the political and electoral process and erosion of corporate personhood in so far as money is considered free speech, as well as more regulation of over the counter derivatives, we will look back at the 2008 crisis and think of it as a relatively calm and orderly time within the financial markets compared to what could happen next.

The coming global debt-driven depression

Reality begins to set in, which inspires panic. Frantic selling across various speculative assets brings prices drastically lower. Retirements and pensions wiped out. Paper investments made effectively worthless. Sound like a repeat of 2008-2009?

The American Nightmare

This horrifying scenario is coming to fruition not because the economy is dipping back in to recession — the fact is without the bailouts, deficit spending and stick saves by the Fed, we’ve been in a depression since late 2008. All of the papering over fraud was about kicking the can down the road rather than fixing the underlying economic, fiscal and monetary imbalances.

Zero interest rate policy combined with reckless fiscal measures have sealed the fate of the US markets and the greater global economy. By implementing such a robust framework without fixing any of the underlying problems on bank balance sheets, in various governments forward debt loads or in household debt we are now looking at repeating the kind of volatility we saw in late 2008 to early 2009, but worse yet there are far greater consequences to a significant economic dislocation. Consequences that were entirely avoidable had the authorities, corporate leaders, banking executives and individual households of the world looked at deleveraging more aggressively and taking the bitter pill that is a brief, but sharp depression so that the excess could be cleared out in favor of rebuilding a more stable and sustainable economy.

Past the Point of No Returns

Now we’re nearing the cliff. The drop-off that is a near mathematical certainty given that many countries governments are reaching their upward debt limit (that is to say no party but their respective central banks are willing to buy their debt). This includes the US, Japan and much of Europe — countries that were once economic superpowers are being reduced to beggar thy neighbor debtors, hat in hand, begging for handouts.

The demographic issues in these areas may differ, but the fundamental economic, monetary and fiscal problems are all too similar. Persistent high unemployment, a highly leveraged financial sector, households that are swimming in debt (with the exception of perhaps Japan) and stock markets that are losing a decade+ in any form of gains.

Worse yet, the forecasts being foisted upon the public are overly optimistic, full of fluffy economic growth predictions that are impossible to achieve. That means that the growth which was necessary to service debt burdens and keep the overly extended economies of the world lurching forward will not occur and thus leaves a much more dire scenario. One of sovereign debt defaults, crashing stock markets, currency crises and an atmosphere of higher unemployment and more civil unrest.

Caution: Debt-Driven Depression Ahead

Let’s look towards the possible future by examining one country that’s already where many will be in the coming months and years ahead. Greece’s stock market is down 85% from its peak, their 1 year government bonds are trading at an absurd yield of about 97% and there is talk of a full scale default as early as this weekend. The Greek people have been protesting, rioting and the unemployment rate by modest measures is 16%. This is a depression, not a recession. While the media is largely ignoring the severity of the crisis, those within Greece are all too familiar with the situation. One that has the potential to become significantly worse before any improvements may happen.

All of the bailouts for Greece have only managed to make the situation worse, because they piled on debt Greece could not pay off while forcing Greece to sell off the few productive assets it has to foreign parties. The combination of these factors ensure a severe economic contraction.

Much of the rest of Europe, with perhaps the exception of Germany, Norway, Finland, Switzerland and Sweden, face the same dilemma: too much debt, too little economic growth. In the United States we face the same crisis, which has only been temporarily offset by the dollar’s reserve currency status — a privilege we may not enjoy for much longer here given the incompetent and dangerous monetary policies of the Federal Reserve. By Bill Gross’ measurement the United States has $75 trillion in unfunded liabilities. That is approximately a 500% debt-to-GDP ratio (over twice that of Japan). Some even say Gross’ measurement is too conservative and the number could be closer to $100 trillion in unfunded liabilities. The fact remains that there is no mathematical or economic scenario where this debt becomes serviceable or sustainable.

The problem is simple, though the solution has been muddled by short-sighted piecemeal bailout attempts. A debt crisis cannot be solved by piling on more debt. It is impossible to achieve economic equilibrium by bailing out corporations that do not know how to manage risk properly. Consumers, who account for 70% of US GDP, are being largely ignored and yet are experiencing significant harm from this crisis. Instead these insolvent banks need to be unwound, brought through bankruptcy and their speculative subsidiaries and divisions need to be completely separated and spun off from their depository and lending functions. We learned this lesson from the Great Depression, but somehow forgot it in the last decade as banks were once again allowed to recklessly speculate with money they did not have.

Modern Banking Is Anything But

Let us remember that banks should really only function as a basic utility for depositing funds and matching those that wish to lend money with those that are seeking interest on savings. That is the vary essential function of a bank. The speculative gambling that occurs on Wall Street has no place in conventional banking and it should never have been allowed to re-join the conventional banking industry.

Those who intentionally defrauded their clients, the government and employed criminal tactics to profit should be indicted, prosecuted and hopefully incarcerated for their crimes against society. Those reckless, greedy and immoral enough to bring down the entire world economy so that they can profit from its artificial rise and subsequent demise are the true threats to a prosperous future. So long as they remain in power we will not see any trust return to the markets nor shall we see any glimpse of true economic recovery. After all, if the rule of law breaks down, there is not much left to keep people from essentially avoiding the entire gulag casino that Wall Street has become.

We must unite around the world and demand that the crooks are prosecuted, the insolvent banks are unwound and that we, the people are not robbed blind to continue to fund these morally and financially bankrupt institutions. It is the only way that we can begin to move forward and start to rebuild our respective countries.

Risk off panic selling, Euro collapse and more

The world markets were roiled today by panic selling. The sell off was catalyzed by negative news on Italy’s solvency, accelerated further by margin calls on major institutions, forcing a major deleveraging across the board. Many are fearing a reemergence of recessionary declines across the globe.

Europe’s outlook has significantly weakened as of late after its been revealed that the fiscal problems of the sagging debtor states are growing more severe at a rapid rate. Headlines today included major exchanges shuttering temporarily, bond issuances being suspended and civil unrest growing. The Euro lost about 1.35% of its value in a single day, a significant sell-off — and one that is likely to continue.

The downside risks for speculative paper assets are intensifying. Growth stocks lost 5-8% or more of their value in a matter of minutes. Some posted double digit losses. The selling in the US continued in to the close without much sign of short covering, indicating that many are still bracing for a negative jobs report tomorrow.

Gold, silver and other precious metals were no exception, as margin calls forced traders and investors who were employing margin to deleverage their portfolio, selling their profitable positions to cover losses, presumably in equities.

The only green on the board was primarily in the US dollar and bonds, once again finding themselves as a safe haven asset during times of panic. One has to wonder, given the underlying uncertainty regarding the US debt, and the condition of global and local financial markets, how long such a phenomenon can last — especially given the tendency for investors to migrate in to hard assets when there’s a whisper of inflation.

The most likely scenario from this point forward is more quantitative easing, probably coordinated by the G7 countries, instead of a unilateral US effort, to prop up sagging markets. Such a liquidity infusion would likely spark a significant rally in commodities and equities, at the cost of the purchasing power of various fiat currencies. Such a powerful inflationary force could cause precious metals to stage vicious upward price discovery as more paper currency is created out of thin air.

In the short term and intermediate term we are looking at a very oversold market. By just about every measure possible we are in a very dangerous zone to be selling stocks. A violent bounce is highly likely, but how sustainable that bounce is depends entirely on what the ECB and Fed say in the coming weeks.

Technically on the S&P 500 there’s a good chance that we’ll see a retest of November, 2010’s lows around 1171 if economic data and news continue to build on the negative sentiment. The 1225 area has now become resistance. This could be the formation of a new trading range or the beginning of a significant downtrend.

Gold made new highs today, but margin calls forced liquidation and brought the price down over $40 from its highs. Silver tested the $42 level, but the same liquidation brought silver down by over 7% at the lows. There’s a good chance that the correction in precious metals could continue if the liquidity vacuum effect of souring debt markets in Europe continues. If instead central banks announce additional easing and credit expansion then we may see a significant rally.

Unfortunately today’s markets are no longer primarily powered by economic growth, but instead moreso from central bank money printing and artificially low interest rates. This is the main reason that more and more investors are turning to hard assets to hedge against, if not profit from, future inflation. If the sell-off continues, with gold, silver and other hard assets seeing discounts, I would consider it an opportunity to buy such assets as the longer term outlook is higher inflation and a resulting attraction towards precious metals.

European Union losing strength

Update: The Fed is moving in to further appease Europe’s ailing banks by restarting the US dollar currency swap program they used during the last financial crisis.

As the EU moves to establish a 750 billion Euro bailout slush fund, political opposition in Germany and the UK is growing and the problems within the EU may be getting more serious.

Hiding the truth

EU politicians claim the fund is being created to defend against the “wolf pack” of banks betting against the Euro and EU sovereign debt.  They say they will defend the Euro at “any cost”.

The reality is that Greece misrepresented its debt, hiding it with the help of Goldman Sachs.  This fraud triggered the downfall of Greece’s bonds once it was discovered.  Other EU countries are now struggling to get their house (of cards) in order.

The contagion could spread

Greece is struggling, if not failing, and with it may come a domino effect. The other “PIIGS” (Portugal, Ireland, Italy and Spain) may also begin their descent on debt woes and poor economic performance.

Even the UK is not immune to these problems as its economy is in bad shape and the debt keeps mounting.  The UK government is facing uncertainty as recent elections delivered a hung parliament, the first such event since 1974.

Germany’s Merkel has potentially exhausted all her political favors as she offered the German taxpayers’ money to Greece in the form of a debt bailout.  Her party has suffered significant losses in recent elections as a result.

Anger grows

Meanwhile, in Greece, where severe austerity measures are being forced on to a weary population, the result has been much civil unrest and violence in the streets.

There have been several deaths, property has been destroyed and no compromise has been reached to temper the rage of the population.

No end in sight

The EU is in a panicked state.  There isn’t any meaningful resolution within reach as they frantically create more debt in a naive attempt to solve a debt crisis.  When other member countries begin to falter the volatility of their bonds, stock markets and currencies may increase dramatically.

Such a significant disruption will spread beyond the EU to the US and Asia.  These headwinds are blowing strong now and could jeopardize the very fragile global economic recovery.

That is, if you believe there was a recovery in the first place.  So much for the Euro being the next world reserve currency.

US dollar index showing head and shoulders

The US dollar index is forming an all too familiar pattern.  This is certainly a result of wreckless monetary policy turning deflation in to a potential stagflationary situation. At this point we recommend purchasing commodities (DYY is a good ETF because it is 2x leveraged and well diversified) and other currencies while there are reasonably priced opportunities.  We like the Euro and Yen for this trade.

US dollar index

US dollar index shows head and shoulders pattern

The courageous may consider purchasing commodities stocks as they will likely participate, but the future of the equities market is not necessarily certain as the recession is deepening.  Today’s unemployment claims were higher than the expected 525k at 573k.  That is a very bad sign that the worst is far from over in terms of how many layoffs we can expect.