Back on November 19 in my Money and Markets column, I listed nine reasons why I expected we were in the midst of a multi-year bull market in the dollar. Then on March 17, I repeated that forecast and said the dollar looks quite good relative to Europe and Japan.
This week that seems to be playing out as we’re getting some technical confirmation of another major leg up in the buck.
Today, I want to review the rationales as given in November, show you some current technical analysis on the buck, and share my long-term target for the euro.
My nine original reasons why the U.S. dollar may have bottomed (as they appeared back in November 2011):
- Credit crunch forces change — U.S. savings are going up; debt sentiment has changed.
- Flight from risk — Euro-zone crisis.
- Growth in U.S. — Not as bad as expected; it’s all relative. Much better in U.S. than Europe, U.K., and Japan.
- Carry trade history — The Fed hiked rates before the Bank of Japan and before the European Central Bank (ECB); and the ECB should be cutting rates soon.
- U.S. assets are very cheap and enticing — A currency plays a major part in that role. Foreign direct investment is improving in the U.S., and some manufacturing is coming back home.
- Sentiment — Newsletter writers still tell us the dollar is doomed. Usually those who don’t trade the dollar, but like to talk about it, are the most strident at the wrong time.
- Correlation — Stock market down and dollar up. If stocks break down, as I expect, the dollar will likely rally on that alone.
- Technical — Upside momentum. Broke its weekly downtrend and has cleared some key resistance on the upside.
- Euro craters as a currency — Crisis peaks. If the euro experiment comes unglued, traders will rush into the U.S. dollar on their way to buying Treasuries.
I don’t have any changes from what I wrote in November, except to say two things:
- The dollar “risk bid” we have witnessed over the past few weeks, could be just the beginning (see correlation chart below) of something much bigger.
- Over time it is in the interest of euro-zone governments to have a weaker euro.
Can You Say “Breakout”?
Just this week, we saw some major confirmation of yet another leg-higher in the U.S. dollar index with a breakout above key resistance at 80.78. My longer term target this year is for a test of the 89.62 March 2009 high (this was triggered by the credit crunch crisis risk bid for the dollar).
Keep in mind, the dollar index is effectively a mirror image of the euro given the euro represents about 58 percent of the dollar index weighting. And the other currencies in the index (with the exception of the Japanese yen) tend to move in correlation with the euro.
Stocks Down and the Dollar Up
There continues to be a tight correlation between the U.S. stock market and the dollar. It is a tight negative correlation i.e. as stocks go up, the dollar tends to go down, and vice versa.
I am quite bearish on stocks and believe this correlation will continue for a while longer. Below is a chart comparing the Dow Jones Industrial Average (black line) to the U.S. Dollar Index (blue line) on a weekly basis. I have added my projected path for each index.
What I See for the Euro
My long-term target for the euro is down around par i.e. 1:1. Sound strange? Keep in mind when the euro was first initiated back in 2000, it quickly sunk to around 0.8400 against the dollar. Given the crisis in Europe and expected deep recession even if the euro as a single currency survives, I don’t think a target near 1:1 is too crazy.
The global macroeconomic environment seems to be deteriorating. Despite the fact the U.S. has its own major problems, in a world where global rebalancing is still playing out, economic growth is fading, and risk is rising, the dollar wins — warts and all.
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