The Dollar is on the cusp of an important move - time to sit up and pay attention

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Eustacia Rogers
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The Dollar is on the cusp of an important move - time to sit up and pay attention 22 nd April 2018 For weeks, we have been pretty neutral on the Dollar in a broad sense.

1 The Dollar is on the cusp of an important move - time to sit up and pay attention 22 nd April 2018 For weeks, we have been pretty neutral on the Dollar in a broad sense. We think this is about to change, and possibly in a way that could hurt a lot of investors. Predicting markets is never an easy game, but one possibility that we think everyone must now be open to (after the February volatility event) is that in all free markets, periods of low volatility are followed by high volatility and vice versa. Chart 1 below shows the US Dollar Index on a weekly basis. We have drawn two trend lines on the chart, which are now converging at a time when price itself has been contained in a very narrow range for 14 weeks. The trend line connecting the highs from January 2017 is proximate with the 21 week moving average which we like to use as a medium term trend delineator. Our basic view is that the Dollar is on the cusp of breaking out of the 14 week trading range. Trouble is, we don t know for sure in which direction (nobody does), and so we have to wait for the breakout and react as quick as we can. For what it s worth, our preference at this moment in time is weighted towards a breakout in favour of a strong Dollar. Chart 1 Weekly US Dollar Index with 21 week moving average (yellow) For the Dollar to break out of its range (as seen on the Dollar Index), the EUR/USD will also have to break out. Chart 2 below shows the EUR/USD daily chart. With the Euro comprising over 60% of the Dollar index, it is to be expected that the patterns basically mirror each other but inversely. We have illustrated two simple potential patterns that are in play; either a rectangle pattern is forming or a triangle. Either way, a breakout will occur at some point. We have shown several times recently that speculative accounts hold a record long position in Euros. Now, it is not inconceivable that EUR/USD can move meaningfully higher even though the market is already quite long. What we would say is that if price begins to break down, especially through and , then those speculators who are long Euros will be under increasing pressure to sell, thereby pushing the price lower.

Chart 2 Daily EUR/USD with 21 day moving average (yellow) Sterling, which has been one of the best performing currencies of late, put in place a bearish reversal pattern last week against the Dollar,

Price last week traded briefly above the late January high, but quickly reversed, leaving behind the look of a bullish failure.

2 Chart 2 Daily EUR/USD with 21 day moving average (yellow) Sterling, which has been one of the best performing currencies of late, put in place a bearish reversal pattern last week against the Dollar, and the indications are that Sterling may be on the cusp of a new downtrend. Price last week traded briefly above the late January high, but quickly reversed, leaving behind the look of a bullish failure. Dovish comments from the unreliable boyfriend (Mr Carney) definitely did not help. To add potential to the bullish failure thesis, the new high last week was unconfirmed by momentum (see in the lower panel). The 21 week moving average has actually worked well in defining the uptrend of the last 18 months. If price breaks below this in the weeks ahead, and the moving average subsequently rolls over, this will only enhance our perception that Sterling is indeed in a new downtrend. Chart 3 Weekly GBP/USD with 21 week moving average (yellow) Casting our net a little further afield, it feels to us like the emerging market currencies are potentially more vulnerable than some of the majors. In Asia, the Dollar appears to be on the verge of breaking out against the Singapore Dollar (shown in chart 4), Korean Won and the Chinese Yuan and may well have already broken out against the Taiwanese Dollar.

Chart 4 Daily Singapore Dollar with 21 day moving average (yellow) One of the recent darlings of the EM world, both in terms of generous yield in a low yield

Here, as shown in chart 5, we see the signs of an almost complete bottoming pattern for the Dollar.

3 Chart 4 Daily Singapore Dollar with 21 day moving average (yellow) One of the recent darlings of the EM world, both in terms of generous yield in a low yield world and capital appreciation from a change in politics, is the South African Rand. Here, as shown in chart 5, we see the signs of an almost complete bottoming pattern for the Dollar. Chart 5 Daily South African Rand with 21 day moving average (yellow) If our view on the Dollar is correct, then investors holding emerging market assets should be especially vigilant. Chart 6 below shows both the US Dollar (inverted) and the largest emerging market equity ETF. The correlation is easy to see.

Chart 6 The Dollar Index and the Emerging Market Equity ETF In the event of a Dollar rally, we don t think that there will be many

It is possible that EM Sovereign spreads begin to widen out against US Treasuries, and if this happens, then investors in US High Yield

Chart 7 shows the spread of both US High Yield and EM Sovereign bond spreads relative to US Treasuries they tend to move together.

4 Chart 6 The Dollar Index and the Emerging Market Equity ETF In the event of a Dollar rally, we don t think that there will be many corners of the emerging market world that will escape unscathed. It is possible that EM Sovereign spreads begin to widen out against US Treasuries, and if this happens, then investors in US High Yield corporate bonds had better be vigilant too. Chart 7 shows the spread of both US High Yield and EM Sovereign bond spreads relative to US Treasuries they tend to move together. Chart 7 US High Yield and EM Sovereign Bond Spreads relative to US Treasuries And we ll finish with one more chart this week; a chart we have shown on numerous occasions in recent weeks, linking the performance of High Yield bond spreads and US equities. Chart 8 US Equity market and High Yield Bond Spread

5 So, to keep things really simple this week. If there is one chart that we will be watching like a hawk in the days ahead, it is the US Dollar. It is our simple belief at this moment that as goes the Dollar, so go all other markets. If the Dollar rallies, then risk assets will be vulnerable, especially emerging market assets. If the Dollar falls, then all will be well in the world. As noted above, if we have a slight preference at this juncture, it is that the Dollar will rally. That said, we must remain flexible as there are strong fundamental arguments for both a weak and a strong Dollar. We will react as the evidence emerges, and we don t think we will have to wait too long. Stewart Richardson RMG Wealth Management

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