To many, the question about the fate of the third major dollar rally since the end of Bretton Woods was resolved last year. The dollar fell broadly. It marked the end the greenback's ride higher.
However, I remain less convinced that this is really the case. And that is what I discuss in this three-minute clip from Bloomberg's What'd You Miss. What I focused on (here) was two-fold. First, that the dollar's decline remains within the parameters of what technicians would regard as a correction.
After a trend, there is a counter-trend that goes in the opposite direction. Sometimes it is a correction and sometimes it is a new trend. The question is how to distinguish between the two, and here macroeconomic analysis may not be helpful. Going back to ancient rice traders in Asia, certain proportions have been used. These days the Fibonacci ratios are commonly used. The most important of these are 38.2%, 50%, and 61.8%.
The euro has not retraced 50% of its losses since the peak in the middle of 2014. Sterling has not even retraced 38.2% of its decline since then.
I suggest in this clip that last year was more about European politics than macroeconomic drivers. After a rallying strongly in Q4 16, the dollar moved sideways in early 2017. When it became clear that the populist-nationalist wave was not going to sweep across Europe, the market began correcting the dollar's rally.
Over time, I expect the macroeconomic fundamentals to reassert themselves. The key is interest rate differentials and the divergence of monetary policy that still has more than a year to run. Now add in the fiscal stimulus with the tighter monetary policy, and that policy mix is among the most beneficial for a currency.
Many observers seem to be curve fitting in the sense that they explain the currency movement by emphasizing short-run correlations. One day it is real interest rates. Another day it is growth differentials. Some days it the external imbalance. Other times, it is inflation or inflation expectations. It is ad hocery at its best.
This is not a robust explanatory model of currency movement. On the other hand, past dollar cycles can be explained by interest rate differentials, policy mixes, and the attractiveness of the investment climate. I think these considerations are still constructive for the dollar.
Opinions expressed are solely of the author’s, based on current market conditions, and are subject to change without notice. These opinions are not intended to predict or guarantee the future performance of any currencies or markets. This material is for informational purposes only and should not be construed as research or as investment, legal or tax advice, nor should it be considered information sufficient upon which to base an investment decision. Further, this communication should not be deemed as a recommendation to invest or not to invest in any country or to undertake any specific position or transaction in any currency. There are risks associated with foreign currency investing, including but not limited to the use of leverage, which may accelerate the velocity of potential losses. Foreign currencies are subject to rapid price fluctuations due to adverse political, social and economic developments. These risks are greater for currencies in emerging markets than for those in more developed countries. Foreign currency transactions may not be suitable for all investors, depending on their financial sophistication and investment objectives. You should seek the services of an appropriate professional in connection with such matters. The information contained herein has been obtained from sources believed to be reliable, but is not necessarily complete in its accuracy and cannot be guaranteed.
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