For years we've heard talk of a coming U.S. Dollar rally which would prove a boon for astute traders. Several years ago I actually had bought into the impending rally myth myself on the grounds that markets are cyclical in nature. I also felt that the U.S. Fed's QE policies would be followed by other central bankers, and by virtue of the Fed being first the U.S. economy would gain traction and lead the global economy out of the Great Recession, which theoretically would lead to an uptick in U.S. interest rates and a U.S. Dollar rally. The U.S. economy did manage to hold its own and other central bankers did imitate U.S. economic policies. However, over the last couple of years as we saw the U.S. economy become more dependent on lower interest rates, and a growing government role for a larger percentage of the population, and it also became apparent that a lower U.S. Dollar was playing a significant role in supporting that dynamic. The U.S. economy is currently a tale of two sectors: public and private. While public sector borrowing has increased - which is bearish for the currency -- it benefits the private sector - which is bullish for business and equities. This mechanism of public sector support of the private sector is not likely to change over the course of months or even quarters but in years. We take Fed Chairman Bernanke at his word that interest rates will stay where they are thru 2015, and that analysis does not even take into consideration disruptive economic occurrences by individual U.S. states or from natural events. The bottom line is the U.S. government's role as a back stop is not going to be shrinking any time soon, which supports the current dollar trend in place which is sideways at best intermediate-term- see Figure 1.
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Figure 1. Monthly Dollar Index Chart
For months I've been mulling over what the market is showing me as far as Aussie strength versus Euro and Yen weakness against the back-drop of U.S. and global economics, and I just couldn't fit the Greenback piece into the rest of the puzzle. Then it hit me that while the dollar may not see a rally much beyond the 2009 highs, that this would still be a large directional move.
The design of the currency markets is fascinating because the only instrument as liquid as a currency is another currency. Sell the Euro and your long the U.S. Dollar by default, albeit .58 dollars. Sell the U.S. Dollar Index and your long Euros, Yen, and Pound's by default. While companies and commodities will always rise and fall, currencies, like temperature bands, stay in relatively reasonable ranges. Even if we were to see the Euro fall 20% it still leaves the Dollar Index right around the 2009 highs. All things being equal that same percentage price move in the Euro and Dollar Index would take USDJPY up a full 16 handles or 1,600 pips. With margin for a standard USDJPY contract a bit over 200 pips you do the math. That would be a tremendous price move, yet it still leaves the Greenback at the top of its current 6-year price range.