There can be no denying that the best trade of 2014 was long the US dollar. The DXY US dollar index was 80 at the start of the summer and ticked at slightly over 100 last month.
Bull markets don’t get any cleaner or simpler than this. All you needed to do was buy the US dollar and close your eyes. If you weren’t instantly onside, you only needed to wait a few days for the market to skate you into the black.
The strength of the rally was truly breathtaking.
It ended up being the strongest advance over the past twenty years!
Inevitably when I speak to buddies who had a good pass last year, I find more often than not it was somehow related to being short some currency against the US dollar. As a Canadian, I know a bunch of guys who were short Canadian dollars in a big way. Yet I can’t help but laugh a little as most of these traders were short Canada because of the “inevitable” real estate bust and the collapse of the oil market. When you look at the performance of the Canadian dollar, it is obvious that the Loonie has been no better or worse than the majority of the other currencies.
Many of these traders don’t realize that their great trade was not that the Canada Dollar was so weak, but that the US dollar was so strong. In reality you could have sold almost any currency in the world versus the US dollar and made money.
And many hedge funds did in fact take advantage of this massive bull market. Have a look at my homegrown indicator of total notional CME speculative US Dollar long positions:
Hedge funds have been buying the US dollar by the fistful for the past six months, and they are not showing any signs of taking the position off.
All the “smartest” guys have the trade on in size. I distinctly remember the tipping point where the US dollar bull market gained legitimacy. It was in October and the US dollar index had just broken out to the upside.
Raoul Pal is one of the most revered gurus in the business. He previously co-managed the GLG Macro Fund in London and went on to found The Global Macro Investor. When he speaks, all the smart guys listen. He is one of the brightest of the brights. Well, in October he said:
“The chart of the US dollar is by far and away the most important chart on earth. If we break the trend line we will be entering potentially one of the biggest dollar bull markets in decades, if not ever. This would be the biggest technical break in the history of fiat currencies. Considering the dollar is the world’s funding currency this has the ability to create havoc on the unprecedented $5 trillion carry trade – with China at the epicenter.”
From then on the US dollar bull market only accelerated. Raoul Pal’s views became the fashionable (and profitable) theme for all the big (and small) hedge funds.
But herein lies the problem. Given today’s mountain of hot money that chases every potential profit opportunity, the US dollar rally has gotten out of control. The Fed has not even being able to get off the first rate increase without the hedge funds pushing up the US dollar at the highest rate in twenty years.
The hedge funds have rallied the US dollar in anticipation of the Fed tightening policy, but the rate of appreciation has tightened policy to the point where actual rate hikes are not needed.
This reality finally became clear with the release of Friday’s abysmal employment report. I will not bother going through the intricacies of the data – there are much better guys out there for parsing what each squiggle means. But the main takeaway was the employment release was disappointing.
I have been harping on the fact there was little chance that the US economy could weather a US dollar increase of that magnitude without it negatively affecting the economy. The Japanese couldn’t handle it when the Yen was the strongest currency in 2011. The Europeans couldn’t handle it when the Euro took over that mantle in 2013. And the Americans won’t be able to handle it now that the US dollar is the undisputed bull market champion.
With the economic data finally agreeing with me, we are facing a dangerous situation. Everyone (and I mean everyone) is long the US dollar in some form or another. Whether it is all my buddies who are short CAD, or the big macro funds with their massive Euro shorts, or even the Japanese retail investors with their long US dollar positions – there is not a single US dollar short left standing. The relentlessness of the US dollar rally has shaken off anyone who might be willing to fade the rally. There is the potential for a violent correction in this US Dollar bull market.
This situation reminds me all too much of the last time Raoul Pal helped cause a bull market in another asset class. In November of 2013 Pal wrote up this analysis of why Bitcoin could be worth $1,000,000 per coin. I will not bother going through his logic, but needless to say that he piqued the interest of many of the “smart guys” and helped cause the stampede from $210 at the time of this recommendation to over $1,200 a few months later.
I am not suggesting that Pal was the cause of this mania, but his legitimacy definitely helped fuel the rally. At the very least he reflected the views of some of the “smart guys” who were pushing BTC higher.
Just like today where Pal’s bullish US dollar views reflect the positioning of most of the other global macro hedge funds. They are almost victims of their own success. The reason for their bullishness is negated by the action they have taken to profit from that fact.
The start of the US Dollar bull market was firmly grounded in solid fundamentals. However like most bull markets these days, the torrent of hot money has taken it much too far. We now have a dangerously overbought market stuffed full of longs whose reasons for owning it are quickly eroding. Taking the other side of their trade makes a lot of sense in here. I am shorting US dollars and buying other assets such as gold that will benefit from the coming unwind.