On the doorstep of yet another much-heralded Fed announcement and in the wake of the BOJ's tinkering yesterday, the US dollar sits fittingly at a crossroads: spring back to its stoic uptrend nearly 19 months dormant—or fall back through intermediate support just a few percent below.
As circumstance would have it, yesterday was also the last official day of summer, to which we say – get on with it. Bring on the fall and bring on the fall in the US dollar.
While there’s certainly no shortage of bubble soothsayers these days, one that’s arguably on the precipice of deflating and which has followed the structure of exuberance – is the US dollar. And although we’ve written extensively of why, historically speaking, we believe the dollar is as extended as it became and remains (see Here, Here, Here, Here), it has largely been motivated by the Fed, or more precisely, the markets' expectations with future policy.
Framing the dollar as a proxy of confidence in the golden age of central banks, where it discretely took flight as the Fed led policy makers in the wake of the financial crisis and soared to icarus heights on misplaced expectations with more contemporary tightening cycles – we'd argue the apparent indecisiveness in the dollar's technical structure today aptly represents the unresolved tensions in the market that we believe will ultimately become unwound, as challenging economic conditions largely limit the reach of the Fed going forward.
Granted, we've found the circumstantial evidence, from both a quantitative and qualitative perspective, in favor of a weaker dollar for some time. The move was as extreme as the cycle high in 1985, as well as the dollar squeeze during the financial crisis. Both performance extremes served to cap the blow off move, as we expect a similar outcome today as the Fed's influence on the dollar continues to wane. From a bearish technical perspective, the next shoe to drop would be a weekly break below ~93 on the US dollar index, which would usher in the next phase (i.e. fear) of the retracement move lower, as expectations of a continuation of the dormant uptrend are largely abandoned.
As we've described in previous notes, the dollar's influence on various markets is significant, with the abstract result that precious metals and commodities should benefit disproportionately, as real yields continue to move lower as inflation firms – but the reach of the Fed is increasingly limited by the economy.
Overall, this market thesis remains on course, as our leading indicators in the silver:gold ratio and the Japanese yen appear to be taking the next step higher, which bodes bullish that the retracement decline in gold is over and the next leg down in the dollar approaches in Q4.
