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Testing the Dollar With Four Primary Metrics


An edge on calling the next dollar move would be huge. But for now it's just not clear...

At risk of sounding like a broken record, in my humble opinion the next move in the dollar is the key to whether "this time is different" and the Fed's games are not enough to keep the house of cards together. Or Boom Boom has indeed bought himself some more time. We know that the dollar index (DXY) is at critical levels and that pessimism around it is rampant. I agree with Prof. Limantour that almost all the ingredients are there for a sharp snap-back rally. But will it happen?
The Structurals:
  • The last two times the dollar teetered on the edge of collapse was in 1972-1974 and 1990-1992.
  • In '72-'74 the US abandoned the Bretton Woods gold standard; oil prices ramped first because of the weakening dollar, and then because of a Middle-East crisis; the US broke from the gold standard as it tried to finance the Vietnam War without raising taxes; the Federal Reserve under Arthur Burns was lowering rates as an election year approached; the concept of inflation measured ex-whatever might actually indicate inflation was first introduced.
  • In '90-'92 the U.S. was in the midst of the S&L financial crisis courtesy of the earlier real estate bubble (which incidentally followed the bursting of the stock market bubble in 1987 and years of lose monetary policy). The Resolution Trust Corporation was established to bail out financial institutions. Oil was spiking thanks to Saddam's invasion of Kuwait. The stock market tanked after the LBO of United Airlines (UAUA) went bust. Citigroup (C) received a bail-out investment from the Saudis.
  • Today we have a credit crisis which is clearly well contained... to our solar system; a messy war; oil prices spiking partly because of the falling dollar and partly because of the Middle-East crisis; a Federal reserve dropping Benjamins from choppers; all kinds of proposed Federal bail-outs for financial institutions and/or borrowers that had no business borrowing; and inflation measures once again ex-anything and everything that is inflated.
  • So structurally we are in a familiar position, and one that does not necessarily imply a currency crisis.

The Fundamentals:

  • A currency is an IOU by a government. The worth of that IOU is based on the creditworthiness of the country.
  • The key tangible measures of a country's creditworthiness consist of the balance in its domestic revenue/spending; its foreign trade activities; and the strength of its economy.
  • The GDP and budget deficit situation does not show anything drastically different from the other two episodes; the problems in both the '70's and the '90's led to a recession, so even if we are heading toward one it does not necessarily mean we'll have a dollar crisis.
  • The US trade deficit is a different story. All you have to do is look at this picture. Is this the swing factor that causes a currency crisis?

The Technicals: (They do not show much...)

  • Back testing various decades for some mainstream indicators (RSI, DMI, Bollinger Bands, Stochastics, etc.) reveals ambiguity at best.
  • In the chart you can glean Head & Shoulder patterns galore in all kinds of time frames, but we are now on the edge of where "no dollar has ever gone before", so I am much more inclined to observe the present rather than trying to extrapolate the future from the past.
  • We do know that in technical terms, the longer a price spends time at or below a support area, the less likely that support will hold.
  • The last time the dollar index fell below 80 (1992-1994), it recovered the 80 level almost immediately. So, in that regard, the next couple of weeks are very important.
  • Drop and pop? Or drop and forget it?
The Psychology: (It fits the current prices.)
  • Few dare sticking their bullish necks out, and those who do make sure to qualify their opinion as "contrarian" with all the caveats implicit to that.
  • The dollar problem if first page news on a slew of newspapers, websites and magazines, including this Sunday's Washington Post.
  • Reading overseas papers it is fair to say that at least Italy is in complete "freak-out" mode over the strength of the Euro. I spoke to a couple of friends of mine who run typical mid-size manufacturing operations in Italy and they are telling me that they are getting killed.
  • The one "negative" item (in a contrarian kind of way) is some of the mainstream media nearly religious conviction that Boom Boom's rate cut will fix all economic evils and lead to a resurgence of the dollar. It's a nice thought but forgive my skepticism.

When I began writing this piece I was hoping to find an edge on the next dollar move, as that would be a huge edge on trading virtually all other markets. I kept the analysis relatively simple because the picture is so "big" in terms of price levels and time frames, that hunting for some arcane indicator that might make you lean one way or the other feels like the wrong approach. Unfortunately, I don't see any edge at this point, but I suspect that when the next move comes, it won't be hard to spot.

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