Dollar Benefits Quarter-End Volatility, But 1.28 EURUSD Still Stands
Fundamental Forecast for US Dollar: Bullish
- US Dollar surges into week, month, quarter’s end
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Thanks to a sharp rally through Friday, the US dollar managed to close out this past week in the green. However, we are once again lacking the conviction of a definable trend for the greenback – whether bullish or bearish. This indecision will not likely last for very long, however, as we head into the fourth quarter. Rather than jumping from headline-to-headline or release-to-release, the markets are facing matters that will redefine investor sentiment and determine whether sidelined long-term investors return or the speculative build up of the past few years is reversed. What we need is the catalyst - both fundamental and technical - that sets us on our course.
Fundamental traders know the dollar’s future is permanently linked to underlying risk trends through its safe haven rank. Therefore, we know to watch the wider ebb and flow of investor capital as the outlook for growth, lending and financial stability shift. It may seem difficult to track these conditions, but there are technical measures that can make it an easier read. And, when we review these different measures, the potential for a large dollar bull trends starts to come through.
The evaluation begins with the level of the capital markets (risk appetite) set against definable measures of reasonable return and risk. For an investor proxy, the S&P 500 hovering just off of multi-year highs (and not far from the previous record) is a reliable representative. A benchmark at these heights would naturally insinuate exceptional market conditions: excellent rates of return, extremely low volatility and heavy building participation to sustain a move higher.
Yet, when we look at the foundation for our current bearings, we see just how flimsy our position is. For ‘return’, global yields are hovering near recent record lows – driven down by unflattering growth trends, persistent deleveraging and stimulus. These unfavorable conditions are tolerated because that same external support from governments and central banks provides a sense of safety that encourages risk taking. Yet, as uncertainty builds, this uneasy balance must rebalance. Given capital has flowed away from the better performing speculative benchmarks – the peak will be lower and the turn more violent.
We can use the S&P 500’s elevation as a good proxy for an overleveraged market. However, we can also draw the same sense from other means. Exposure in net speculative futures positions is another reflection of ‘extreme’. We’ve seen in last week’s COT figures that net positioning in the carry favorite Aussie dollar climbed to a 17-month high (and just short of a record) where only three months ago it was at a record net short. Euro futures exposure isn’t as extreme, but the steady climb back towards a neutral reading creates tension with the recent slide for EURUSD. And then there is net dollar exposure which plunged from a record long to near record short.
So, taking stock, we have seen the markets driven to extremes as the fundamentals remain anchored to a far more anemic reality. The pressure is there, it’s just the catalyst that is needed to break the dam. I have expected the changing of the guard for some months now, and the transition simply hasn’t occurred. We need the correct mix of issues rendered inert while others take the helm.
The expectations of more stimulus was a big hold up for the past few months (and really for the preceded couple of years). With the Fed’s open-ended QE3 and ECB OMT, we have likely seen the crest of support…and it will likely be deemed insufficient to win further capital market gains on lackluster participation. The ‘Fiscal Cliff’ can be another hang up, but there are no real positive outcomes. Now, we transition back to the transparent investment drivers. The Euro-area crisis will now be judged with all the stimulus cards laid out. The third quarter earnings season will caste a harsh light on returns mid-October. This week, we refocus on growth as manufacturing and jobs data looks to reflect upon the best and worst aspects of the US economy. The pieces are in place, we just need to set it all in motion. – JK