All Good Things Must Come to an End

I’ve based most, if not all of my investment decisions around the performance and perceived outlook of the US dollar. It has certainly been a fairly consistent marker of global risk appetite versus risk aversion for as far back as I can compare financial data with the macro-economic narrative of the day. I have recently completed a full turnaround of my foreign exchange portfolio from net long dollar to net short dollar. The trading decision to turn the portfolio around was based on technical signals from my charting software, and the analysis it allows me to perform of the prices of my preferred securities. The conviction to initiate and follow through with the reversal comes from a compilation of my interpretation of my trading signals, and the evolving macro-economic environment.

My technical analysis of the price movements of a few dollar exchange rates have highlighted several consistencies with some trading signals and the directional magnitude of the market outcome of macroeconomic data and information. Though the individual currencies in the portfolio paint their own pictures of their respective economies on the ground relative to the dollar, the index acts like a weighted average for comparison. This average represents the sum of all greed and fear in international capital markets. In a nutshell, as of recently, the signals that I have been interpreting from my technical analysis have all been pointing to international capital markets that are finding fewer and fewer reasons to be fearful of the near-term macroeconomic environment. With this easing of sentiment, the dollar will lose its allure as a safe-haven in exchange for rising foreign yields.

The picture painted by my technical analysis of my charts tends to coincide with the macroeconomic narrative that the Federal Reserve and most market commentators seem to subscribe to. It is worth mentioning that as before, the mistiming of a macroeconomic insight and a financial market decision making has left me needing to actively manage my hedging efforts while I wait for the rest of the party goers to realize the festivities are over.

While We Wait

The US dollar is accepted practically everywhere, and is used more than any other currency for international transactions. The US economy by most measures is still the largest and most productive economy on earth. This puts the United States in an interesting position; some might say dilemma.

When the US economy was growing at its potential and the dollar was falling, a large portion of exports generated in emerging and developing markets were either meant to be sold in the US, or processed elsewhere before being sold in the US. Inversely, those same exporters were the ones consuming the technology and intellectual property being exported by the United States. But as it currently stands, the US economy is rehabilitating from the traumatic effects of the 2008 Global Financial Crisis and resulting economic spillover. Meanwhile the dollar has been rising almost vertically for the last five years or so. This recent trend in the dollar translates to a general level of unease - - not necessarily fear - - in international financial markets. US economic data have been overall positive and improving. But with the demographic shifts that are beginning to accelerate in developed economies, along with already monumental levels of private and public debt, sources and drivers of sustainable growth are few and far between. That being said, historically the safest place has been the US dollar in times of economic uncertainty.

The current consensus is that this summer, conditions will be ideal for the Federal Reserve to begin re-adjusting its stance on loose monetary policy. This will undoubtedly be a significant signal from the Fed to US and global financial markets that the economy is once again growing on a sustainable path that can lead to a zero output gap. This signal will inevitably filter into foreign money markets and interest rates will adjust in other economies closely linked to the US. Once local prices adjust, in response to inherent sensitivity to funding costs, monetary policy in other major economies will begin to re-align as well. This scenario plays out if the signal from the Fed is reinforced by subsequent steps towards further policy tightening. This of course, can only happen if the US economy is once again growing on a sustainable path that can lead to a zero output gap.

In the meantime the dollar is beginning to consolidate, and somewhere out there, investors are positioning their portfolios for long anticipated news from the Fed on how the US economy is really doing via monetary policy signals. The Fed, in turn is waiting on signals in the economic data to discern the future of monetary policy; and in the real world, people go about their daily lives.