Home > Economics, Investment Ideas, Trading > More Dollar Strength on the Horizon

More Dollar Strength on the Horizon

This post originally appeared on T3Live on January 12th, 2010.  This theme continues to play out and the trade continues to work.

In looking at a daily chart of the Euro (FXE), we can see the development of a bearish continuation pattern–the bear flag. The FXE index struggled mightily with the $150 level. After what appeared to be a breakout failed above that level, the currency quickly reversed course and traded lower.

Drawing in the Fibonacci levels shows that the recent rally stalled at exactly the 38.2% retracement level of the move from the November highs to the December lows. Aggressive traders looking to anticipate a breakdown can use yesterday’s high of $145.30 as a level to short against.

In taking a step back and looking at a monthly chart of the Euro, we see a bearish engulfing bar in December that wiped out nearly four months worth of gains for the currency. The next big level appears at around $140 on the FXE and will be a crucial tell as to whether lower prices are in store for the Euro and consequently higher prices for the dollar.

Several fundamental factors add up to add fuel to this potential move. Firstly, the Euro zone appears to face some significant troubles in the near future. Sovereign debt concerns in the PIIGS nations–Portugal, Ireland, Italy, Greece and Spain–has some talking about a move away from the Euro in the troubled countries. While such a move seems drastic, and is most certainly not imminent, the uncertainty that comes with growing public debt without localized monetary policy control will continue to weigh on some countries in the Eurozone, and vicariously weigh on the Euro.

Secondly, deflation in the private sector in the U.S. remains persistent. Demand for dollars and the need to capitalize outstanding debt are ultimately positive catalysts for the price of the dollar. While asset prices continue to appreciate in price, real demand in the economy remains sluggish. Case in point are the Alcoa (AA) earnings. The Market Guardian summed it up well in a post from yesterday evening:

The primary uses for refined aluminum are automobiles, aircraft, trucks, railway cars, marine vessels, bicycles, and other machines, as well as packaging such as cans and foil, along with construction with windows, doors, siding, building wire, studs, and framing, plus in a range of household items and consumer electronics.

Is manufacturing in any of these areas which extensively use aluminum improving? NO.

Will manufacturing using aluminum increase significantly in 2010. NOT LIKELY.

So, then, why exactly isn’t Alcoa’s stock price reflecting a dramatic drop in the use of aluminum and why isn’t the price of aluminum itself down substantially rather than up due to much lower demand?

The lack of end demand in the economy makes it increasingly likely that the Federal Reserve Bank will not raise interest rates as soon as some may think. The dollar rises when demand for dollars outpaces supply. Should the dollar breakout yet again here (and the Euro breakdown), we will have confirmation that private sector deflation is happening at a far greater rate than public sector inflation. Watch the FXE closely for the next tell.


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