Yesterday I saw the following story cross my Bloomberg:
Dollar in Longest Rally Since Days of Beatles Albums; Yen Drops
The dollar had the longest rally since teenagers bought Beatles albums and Lyndon Johnson was president as the Federal Reserve signaled interest rates will rise next year while other central banks pushed stimulus plans. The U.S. Dollar Index rose for a 10th consecutive week, the longest since at least March 1967.
It has been pretty well a straight up kind of affair.
One of the fellows at the office has had a good size Yen short on the whole way and yesterday he remarked at how it was the first day in quite some time that his P&L actually decreased.
As I heard that my trading antennae perked up and I realized that it was probably time to try a short US dollar position. The money has come easy for the US dollar bulls and we are due for a correction.
Earlier in the summer I was long US dollars and, as usual, I abandoned my profitable trade too early. I have been hesitant to either climb back aboard the crowded bull train as I believe that the market is overly optimistic about the prospect of the Fed raising rates. So I have sat and watched the monster bull move develop, content (or maybe frustrated?) to be on the sidelines.
I have been waiting for a sign that the move might be topping out before trying to step in front of this freight train. With the Bloomberg article and my buddy’s comments, I decided it was time to take a stab on the short US dollar trade.
Yesterday I put on a small Yen long. I actually don’t think it matters which currency you choose because I think the US dollar is going to trade lower against them all over the next couple of weeks.
Even if you think the Fed is going to hawkishly raise rates, given past rate hikening cycles, we are due to take a break in the US dollar bull run. Have a look at this great chart from JP Morgan that highlights the US dollar performance around this period:
The interesting thing to note is that the current bull move is roughly spot on in terms of previous moves. It seems that the US dollar rallies ahead of the first rate hike, but then goes sideways for quite some time.
Hopefully even if I am wrong about the prospect of the Fed being more dovish than the market expects, it won’t matter because the current US dollar rally has already built it all in.
Plosser steps down
Charles Plosser, the hawkish president of the Philadelphia Fed, on Monday announced he will retire in March. He’s currently a voter on the Federal Open Market Committee, who dissented from the statement in the last decision, but the Philadelphia Fed president after this year won’t get a vote until 2017. Plosser has been president since Aug. 2006.
When Plosser announced his resignation from the FOMC there was of course many comments about how the Fed is slowly losing all of its hawks. There is no doubt that that Plosser helped balance the dovish Fed.
But we need to remember that he wasn’t going to get a vote for the next couple of years anyway. Even if he had stayed, his hawkishness would have done very little to change the outcome of Fed policies.
Will Draghi be able to deliver?
A couple of weeks back when Draghi made his pledge to expand the ECB’s balance sheet to summer of 2012 levels, there was much optimism that Europe finally “got it.” Smart traders like David Tepper were convinced that Draghi was going to be able to stop the deflationary self reinforcing spiral:
“Draghi wants inflation in the Euro zone. He will not stop,” said Tepper
But I wonder if we aren’t over estimating Draghi’s ability to get things done. This is after all Europe. And if there is one thing that we should have learned from the European sovereign debt crisis it’s that it is extremely difficult to get all the different EU members to agree on anything unless the dissolution of their union is staring them in the face.
The recent LTRO was rubbish. €82 billion is a rounding error on the ECB’s balance sheet. They need to be adding that amount every couple of weeks, but we have to wait until December for the next LTRO which they hope will be more successful.
Although I don’t doubt that Draghi wants the ECB balance sheet to expand, the real question is will he be able to deliver?
On the ECB meeting day the market gave him a big benefit of the doubt. Traders like Tepper took Draghi at his word and altered their portfolios based on an expanding ECB balance sheet.
For a week or so, the market started to price in an end to the downward move in inflation.
But the reality is that this is not going to happen overnight. The optimism that followed the previous ECB meeting has faded and the market has resumed pricing in lower and lower inflation.
The Germans are going to fight the balance sheet expansion the whole way, and it is increasingly looking like things will need to get worse before there is any urgency to act.
I was hopeful that the ECB “got it.” But they really don’t understand that they are in danger of becoming Japan.
Given their lack of urgency, and the fact that the ECB balance sheet will not be able to expand without the credit being force fed into the system, I am covering my Bund short.
I believe that QE programs are inflationary, and that without it, Europe will continue in their deflationary self reinforcing spiral that will make the European bond markets all the more attractive. In addition, even though most will argue that the Euro should go lower, I contend that a lack of ECB balance sheet expansion might cause the Euro to resume its upward trend. Don’t forget the problems that Japan experienced with a strong currency before the introduction of Abeconomics.
Europe is a mess and although it seemed like Draghi’s soothing words would be able to fix it, I am becoming more and more concerned that the problems will have to get a lot worse before they get better.
Last week it felt like all the headlines for stocks were bullish. We had the Alibaba euphoria and new highs in the Dow Jones and S&P 500.
Even though it appears like all is well, there are more and more signs of cracks at the seams.
US small caps are trading heavy, with the Russell 2000 no where near the highs like its big cap brothers.
And emerging markets are not only not near their highs, but have made a big move and are breaking down.
I understand that some of that weakness can be attributed to the US dollar rally, but there can be no denying that the emerging markets are not confirming the recent US large cap move to new highs.
For a whole host of reasons, global growth is slowing. It is being exacerbated by the US QE wind down and the Fed rate hike expectations. This has caused commodities, which are sensitive to global growth to fall.
Copper which has a reputation of having a PHD in economics in terms of forecasting economic growth has been weak. And emerging markets have traditionally followed copper very closely.
Will this resolve itself with a move lower in EEM? Or will copper rally back up? Maybe a bit of both?
Either way, these are not bullish looking charts. Be careful out there with your longs… you don’t want to overstay welcome.
Yesterday we had some more weakness in the GDX square. I added to my small GDX position. I intend to really load up the boat at some point, but right now I am just picking away, adding to the position into weakness.
With the gold weakness they are crushing my little gold junior CRK CN Equity. I bought some more of that into the recent drubbing.
And finally, I had said that I wanted to re-load on my INP CN position in the low 2s. Yesterday I decided to buy some more at $2.25 as it came under pressure from a big seller.