U.S. Dollar In Freefall - Here's the Impact

Posted by jbrumley on July 18, 2017 2:20 PM
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If there was any lingering doubt that the U.S. dollar was in trouble, it was wiped away today. Down 1.0% for the session (a massive move by currency standards), the U.S. Dollar Index has plowed into multi-month low territory. The sheer scope of the setback suggests we may see a mild pushback effort soon -- as in later this week -- but it's become quite clear the greenback is in freefall mode.

The weekly chart of the U.S. Dollar Index below tells the tale. With today's tumble to the current value of 94.49, the dollar is now more than 85 off its late-2016 high, yet there's still plenty of room to go before the first big technical floor at 93.1 is tested... and there's no assurance that support will stop the bleeding.

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The prod for the pullback isn't an intuitive one. Broadly speaking, a country's currency moves in tandem with its interest rates, and/or inflation. The Federal Reserve may be dovish, but there's still little doubt it has every intention of ratcheting interest rates up through early next year. Similarly, though the pace of inflation growth is cooling, inflation is still cooling off at reasonably healthy levels.  These are in and of themselves not the kind of prompts that would drive the dollar lower the way it's peeled back this year.

Also meaningless are the suggestions that White House Scandals and stalemate in Washington are up-ending the nation's currency, with traders fleeing the country's currency in fear or geopolitical turmoil. Such ideas make for great headlines, but no serious trader actually feels those kinds of things stop global capitalism.

No, more than anything else this sharp pullback from the U.S. Dollar Index serves as a referendum of the largely unmerited runup of the U.S. dollar in 2014 and early 2015. The move materialized in anticipation of a Fed turning very hawkish, imposing rate hikes at a breakneck speed. The economy ended up being far more even-keeled than anticipated.

Thus far traders have been unwilling to unwind the trades that prodded the big rally. Indeed, they even added to it late last year. It's all but impossible to recognize now, though, that those speculations were unnecessary. The selloff since the end of December is at least a partial unwinding of that mindset.

It's not a bad thing, of course. Indeed, there are several advantages to a weak U.S. dollar. One of them is stronger oil prices.

Few care to acknowledge it, but just as much as a supply glut caused oil prices to crater beginning in 2014, the rising U.S. dollar did the same. The graphic below illustrates the correlation of crude prices and the greenback. With the U.S. Dollar Index moving lower in a big way, we're already seeing some new bullish pressure on oil. A move above a key technical ceiling at $52 would seal the deal.

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A falling dollar is also a bullish prod for other commodities, and gold in particular.

The mostly-overlooked beneficiary of a weaker dollar, however, is American companies that sell goods and services overseas.

Many of the quarterly earnings reports since 2015 have brought attention to the special footnotes that explain the impact adverse exchange rates -- it was nothing unusual for a poor currency exchange to shave between 3% and 6% off of a company's bottom line. That measure only tells half the story, however. In many cases, U.S. companies couldn't do business overseas at all simply because foreign buyers were unable to make a purchase even after steep discounting.

With the sawbuck now in decline, that headwind will go away altogether for many of the nation's enterprises.

It's too soon to assume anything yet. The downtrend has been decisive, but sharp selloffs invite big reversals, and odds are good there are a whole bunch of would-be buyers waiting to pounce if-and-when the U.S. Dollar Index reaches the 93.1 level. If that line for some reason doesn't hold the sellers back though (and we can't rule the possibility out), that could be a game-changer for all facets of the market... mostly bullish ones, as long as the greenback doesn't fall to far, too fast.

Whatever the case, if the dollar wasn't on your mental radar, put it on your radar now.

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