Timing the Dollar’s Run

The U.S. Dollar has been the best house in a bad neighborhood since the U.S. Federal Reserve Board announced its intentions to taper the U.S. economy off of its monthly stimulus supplements. Protracted issues in Ukraine and the sanctions levied against Russia have created a major capital flight from Eastern Europe as a whole. The European Union recently announced its own form of Quantitative Easing and finally, on Halloween, Japan dropped the mother of currency bombs. Their announcement that they would not only invoke another round of currency destruction but would also become direct investment participants in their own stock markets created a shock through the investment landscape that I’ve not heard in non-crisis times.

Television pundits have been calling for currency defaults since the economic implosion of ’08. First, it was the U.S. Dollar. Ben Bernanke was going to destroy our country with his book smart/street stupid ways. He was going to undermine the U.S. Treasury and the world’s faith in the Dollar. It hasn’t happened. Next, the crisis moved to Europe. The European Union would never be able to come to an actionable consensus. The economic strains would rip apart the young ties of a poorly constructed contractual agreement among the Union’s nations. It hasn’t happened, yet. Finally, the sun has been setting on Japan since the early 90’s. The current regime’s attempts to destroy the Yen has been deemed QE – 11 by those who keep track of such things.  All the while, their sun has yet to set.

Often times, market letters and TV pundits have an agenda to push. Perhaps, more often, it’s just the noise of the crowd that necessitates a wild claim to stand out from the pack. The point is that hyperbole gets the press but rarely gets it right. The scenarios previously mentioned may all come to pass, eventually. Currently, I believe a different scenario is shaping up and while I may agree with the broad themes of global affairs, I think the currency markets may have gotten ahead of themselves a bit.

Most of our research is based on the CFTC’s weekly Commitment of Traders Reports. The report tracks three main groups; large speculators (commodity funds and pools), small speculators (individual traders and small pools) and finally, the commercial traders. The commercial trader category is made up of the businesses that use the products they’re trading. Collectively, they have access to the best information, models and traders available. When they speak in unison, as they are now, I listen.

Beginning with the U.S. Dollar Index itself, you can see that the Yen and the Euro currency are responsible for 70% of the movement in the index.

composition of the dollar index
The Japanese Yen and the Euro Currency are responsible for 70% of the movement in the U.S. Dollar Index.

The Dollar Index has broken through major resistance on the chart below but, it does so in the face of a near record net short commercial trader position.

dollar index breakout failure
The U.S. Dollar Index faces considerable commercial trader resistance.

The real issue isn’t just the heavy commercial selling the Dollar is facing as it tries to continue its rally. The real issue is that the same forces that are attempting to hold back the Dollar are also supporting the Yen and the Euro independently. Look at the Euro Currency chart below.

euro currency support at $1.20
The $1.20 area has been heavily supported by commercial traders.

Finally, lets take a look at the Yen chart which confirms the same thing, once again.

yen 115 to the dollar
Will commercial traders be able to hold the Japanese Yen above 115 Yen/$?

Commercial traders in the Japanese Yen set a record net long position at the end of 2013. They’ve clearly stepped back in on the buy side as the Yen nears the critical support at 115-117 or, 80-85 in the CME Japanese Yen futures.

When these charts are taken as pieces of a whole, we find corroborating evidence to support the notion that while the fundamental macroeconomic issues are sorted out over years, trading opportunities are not. That being said, the idea is to put ourselves in a position to generate the most bang for the buck or, dollars per day in the market. Therefore, we will be monitoring the interaction between these three currencies and looking for reversal opportunities. In the near-term, where we trade, we expect the Dollar to pullback from these lofty levels and provide long-term trend traders with another, cheaper entry point.

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