Sunday, November 13, 2016

Currencies: "Focus on Policy Mix Strengthen Dollar Bull Case"

From the intro to a November 2009 post, "Brown Brothers Harriman: Too Soon to Call the End of Rally":
I have a soft spot in my heart [head? -ed] for Brown Brothers Harriman. Not only is the Brown Brothers side of the business one of the oldest members of the exchange (founded 1818) but the Harriman side of the biz was founded by the sons of one of my childhood heroes, E.H. Harriman....
..."I can distribute more stock on upticks than I can on down"
-E.H. Harriman, railroad man and Wall Street pro.
From Brown Brothers Harriman & Co's Head of Global Markets Strategy, Marc Chandler:
Our bull case for the US dollar has been predicated on the divergence of monetary policy and the relative health of the financial system.  What is new, and investors are anticipating, is fiscal policy.  

After several years of reducing the budget deficit, both Trump and Clinton promised fiscal stimulus. Trump offered more infrastructure spending and tax cuts than Clinton.  His economic team, though formal appointments have yet to be announced, suggests $1 trillion fiscal stimuli (~6% of GDP), which is larger than even Sanders advocated in the primaries.  

At the same time, investors are more confident of a Fed hike next month. But more than that, the derivatives market is beginning to price in a more aggressive Fed.  A few days before the election, investors learned that average hourly earnings rose by 2.8% year-over-year.  This is the fastest in several years, and although one month a trend does not make, it is consistent with a tightening of the labor market, and rising core inflation pressures.   

This policy mix, tighter monetary policy and looser fiscal policy, is the most constructive combination for a currency.  The magnitudes may be different, but that was the Reagan-Volcker mix that fueled the dollar rally of the early 1980s.  It was also the policy mix that Germany pursued after the Berlin Wall fell.  That policy mix led to the dramatic appreciation of the German mark and precipitated the European currency crisis, which itself gave impetus to the Maastricht Treaty and the birth of monetary union.  

The US dollar rose against all the major currencies last week but sterling, which was bolstered by the unwinding of the long euro and short pound positions.  The US Dollar Index rose each day last week, after falling for the previous four sessions.  We had anticipated the dollar to have sold off if Trump was elected.  We were close to the magnitude of the Dollar Index but was surprised at how quick it recovered.  

Last week, we had suggested an initial retracement target near 96.60 and thought if that went, there could be a test on a trendline that came in near 95.80 on November 10.   In the immediate reaction to the election news, the Dollar Index was a little below 95.90.
Despite the dramatic recovery and the five-day advancing streak, the technical indicators signal generated by the RSI, MACDs, and Slow Stochastics point to scope for additional gains. There are a few levels that offer near-term targets.  The high for the year, set in January is near 99.85 and the high from March and December last year was around 100.50.   Over the somewhat longer term, we note that the 101.80 area is the 61.8% retracement of the decline from 2000 when it peaked near 121.  

The euro closed at 1.1140 on November 4.  We had thought it could spike to $1.14-$1.15.  It made it up to $1.13 before reversing sharply.  It fell each day last week (-2.8%) and made the lows for the week just before the weekend near $1.0830....

Here's the last year of the U.S. Dollar Index (DXY) from FinViz: