Fundamental Forecast for US Dollar: Bullish
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Thanks to a sharp rally through Friday, the US
dollar managed to close out this past week in the green. However, we are
once again lacking the conviction of a definable trend for the
greenback – whether bullish or bearish. This indecision will not likely
last for very long, however, as we head into the fourth quarter. Rather
than jumping from headline-to-headline or release-to-release, the
markets are facing matters that will redefine investor sentiment and
determine whether sidelined long-term investors return or the
speculative build up of the past few years is reversed. What we need is
the catalyst - both fundamental and technical - that sets us on our
course.
Fundamental traders know the dollar’s future is
permanently linked to underlying risk trends through its safe haven
rank. Therefore, we know to watch the wider ebb and flow of investor
capital as the outlook for growth, lending and financial stability
shift. It may seem difficult to track these conditions, but there are
technical measures that can make it an easier read. And, when we review
these different measures, the potential for a large dollar bull trends
starts to come through.
The evaluation begins with the level of the capital
markets (risk appetite) set against definable measures of reasonable
return and risk. For an investor proxy, the S&P 500 hovering just
off of multi-year highs (and not far from the previous record) is a
reliable representative. A benchmark at these heights would naturally
insinuate exceptional market conditions: excellent rates of return,
extremely low volatility and heavy building participation to sustain a
move higher.
Yet, when we look at the foundation for our current
bearings, we see just how flimsy our position is. For ‘return’, global
yields are hovering near recent record lows – driven down by
unflattering growth trends, persistent deleveraging and stimulus. These
unfavorable conditions are tolerated because that same external support
from governments and central banks provides a sense of safety that
encourages risk taking. Yet, as uncertainty builds, this uneasy balance
must rebalance. Given capital has flowed away from the better performing
speculative benchmarks – the peak will be lower and the turn more
violent.
We can use the S&P 500’s elevation as a good
proxy for an overleveraged market. However, we can also draw the same
sense from other means. Exposure in net speculative futures positions is
another reflection of ‘extreme’. We’ve seen in last week’s COT figures
that net positioning in the carry favorite Aussie dollar climbed to a
17-month high (and just short of a record) where only three months ago
it was at a record net short. Euro futures exposure isn’t as extreme,
but the steady climb back towards a neutral reading creates tension with
the recent slide for EURUSD. And then there is net dollar exposure
which plunged from a record long to near record short.
So, taking stock, we have seen the markets driven to
extremes as the fundamentals remain anchored to a far more anemic
reality. The pressure is there, it’s just the catalyst that is needed to
break the dam. I have expected the changing of the guard for some
months now, and the transition simply hasn’t occurred. We need the
correct mix of issues rendered inert while others take the helm.
The expectations of more stimulus was a big hold up
for the past few months (and really for the preceded couple of years).
With the Fed’s open-ended QE3 and ECB OMT, we have likely seen the crest
of support…and it will likely be deemed insufficient to win further
capital market gains on lackluster participation. The ‘Fiscal Cliff’ can
be another hang up, but there are no real positive outcomes. Now, we
transition back to the transparent investment drivers. The Euro-area
crisis will now be judged with all the stimulus cards laid out. The
third quarter earnings season will caste a harsh light on returns
mid-October. This week, we refocus on growth as manufacturing and jobs
data looks to reflect upon the best and worst aspects of the US economy.
The pieces are in place, we just need to set it all in motion. – JK
Source : www.dailyfx.com
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