Removing Dollar Catalysts
The dollar has rallied through the month of February as a result of a number of bullish catalysts. Technical support, Italian elections, FOMC minutes, and ECB meeting expectation were all reasons to be bullish on the dollar. I believe these items are behind the dollar and it’s time for a correction. It could also be inferred that a rally is due in commodities. The only thing holding back a dollar correction is a strong employment number tomorrow. That question will be resolved soon.
Since early 2012, the dollar has been range-bound with support near 78.50, resistance at 81.50, and extreme resistance at 84.
Recently the dollar broke above 81.50 and is currently trading near 82 after a nice sell off today. From a trading perspective, the dollar is overbought with a 14-day RSI level retreating from 75 (currently 65). I’m watching to see if the dollar can fall below 81.90 for a sell signal, but I’m already hopeful of such an event based on the RSI’s retreat and the ECB meeting today. If I’m wrong and the U.S. employment is strong tomorrow, we could see the dollar continue on towards 84. The current short-term trend on the U.S. dollar is up.
Nulla é Nuovo Sotto il Sole
There’s nothing new under the sun in Italy. Although the currency markets, European sovereign bond markets, and the world stock markets were upset over the prospects of the Italian election, we saw the same thing in France last year with the Presidential nominee, Francois Hollande. Hollande was promising to withdraw some of the austerity measures or curtail them in favor of more pro-growth ideas…and he won.
The markets were concerned whether Bersani or Berlusconi won as Berlusconi was promising to fight Germany over Italian austerity measures to increase his popularity with the voters. With the draw in the elections between the two parliaments, it’s looking like a confidence vote will be made in late March with a vote on the new President mid-April. Bersani will try to form a government without another technocrat government. It doesn’t really matter which party wins in this election now, because Bersani has recently made it clear, he too wants to “leave the austerity cage”.
Since the elections, Italian sovereign yields have eased as investors become desensitized with the elections; as Mario Draghi put it today, “markets were less impressed than you” (i.e. the press).
Italian 10-year Bond Yield
While the FOMC chairman’s comments have continued to be dovish, his fellow committee members continue to debate the efficacy and the expiration term of one of its current policy tools in action, quantitative easing. This debate has been expressed in the FOMC minutes over the past two months and has served as a bullish catalyst for the U.S. dollar upon its release. As I have been saying since September, the data-dependent instead of date-dependent nature of the recent implementation of QE has increased the power of Fed-Speak to talk down inflationary expectation.
Despite the fact that the Federal Reserve Bank is injecting an additional $85 billion per month into the monetary supply, gold is relatively near its two-year lows and other commodity prices remain “in check”. The recent release of the January minutes released on February 20th, saw gold retreat nearly $50 on the day. It is hard for me to believe that gold is lower today than when QE was first initiated, but commodities continue to languish as traders have moved on to other asset classes. Yet there is hope in that $1550 continues to hold for gold and the February waterfall correction in gold and other commodities seems to be on hold.
Last week, we heard from the Fed Chairman before the House and the Senate Finance Committees. He supported QE for as long as necessary to meet their dual objective of full employment and low price inflation. After the chairman’s testimony and after only having one dissent at the latest FOMC meeting, I think it’s fair to presume we’ll continue to have QE for some time. Yes, they’ll continue to “manage” inflationary expectations with Fed-speak, but it won’t be until we get some escape velocity to the economy that it will be removed. With fiscal policy at odds with monetary expansion, we can expect the economy to muddle along until both policies line up; which may be a while.
ECB Contracting, Fed Expanding
If you’re bearish on the euro then you’re bullish on the dollar. One of the catalysts that has applied pressure on the euro since last week has been expectation the ECB would lower interest rates at today’s policy meeting. The Eurozone’s economy continues to languish with a down revision to GDP as of late. Draghi continues to anticipate growth in the second half helped by global demand, current policy accommodation, and financial market calm. He does, however, acknowledge that the growth outlook is biased towards the downside, which is why policy remains accommodative despite the rally in both stock and sovereign bond markets.
Today, the ECB left policy unchanged. Since didn’t ease policy, this should strengthen the euro over the short-term. The euro was able to rally from 1.2965 at the open to close at 1.3107 on the day. With the euro near 55% of the dollar index, this should help weaken the U.S. dollar. Another catalyst that should be strengthening the euro over the dollar is the contraction in the ECB’s balance sheet. Long-term refinancing operations (LTRO) were loans given to European banks for a 3-year period at 1%. Those are being repaid back to the ECB, which is a form of contraction to monetary policy. This should strengthen the euro in theory as the U.S. Fed continues to expand its balance sheet every month.
ECB Balance Sheet
Tomorrow’s employment figures are unknown, but the results will be quantifiable in the reaction of the currency markets on the dollar. A strong number will bid up the dollar while a weak number will weaken the dollar on the expectation that QE will be here much longer. Whether you believe in the government’s statistics is irrelevant. The market will react to a beat or a miss. February’s consensus is for 160,000 jobs at this point in time according to Standard & Poor’s.
Some of the catalysts that have bid the U.S. dollar higher seem to be dissipating. The more important one was the ECB meeting today which caused the euro and commodities, priced in U.S. dollars, to rise. This could be the beginning of a turn for the euro and commodities, but we need one more catalyst to set things in motion. That could be the U.S. employment data tomorrow. Needless to say, it will be an important news release – for U.S. stocks as well.
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