Have you ever seen a pig on LSD ? Me neither but I’m told it doesn’t know which way to run.
Same with the USD.
It’s always difficult to pinpoint where we are in terms of a trend. Long-term trends in the currency markets have ranged from six to ten years, measured by the various bull and bear markets in the dollar since the inception of the free-floating currency market back in 1971.
Here’s the pattern of long-term bear and bull markets in the dollar as measured by the US $
1971-1978: Seven-year bear market (End of the Gold Standard)
1978-1985: Six-year bull market (Fed Chairman Volcker kills inflation)
1985-1992: Seven-year bear market (“Punish Japan” Plaza Accord)
1992-2001: Ten-year bull market (Tech boom and E-Greed)
2001-2008: Seven-year bear market (US/China Symbiotic relationship)
2008- ? : Next major bull market underway (Credit Crunch triggering global rebalancing)
The key assumption here is price action exhibits wave-like characteristics and these patterns flow naturally from real people, with human emotion, react to the environment and the leadership of the crowd. Based on those assumptions, we have defined stages for the movement of the dollar (as any other asset class moves) and added some specific dollar narrative.
Six Stages of the dollar…
Stage 1: The unrecognized trend – This is the early on stuff. It represents the beginning of a new trend that is recognized by only a few of the major players. The zenith of the recent credit crunch was when the US government saved highly levered investment bank Bear Stearns (second week in March 2008). It also happened to be exactly when the US dollar index bottomed and began its new bull cyclical phase—now in its ninth year. One could see the bounce in the dollar on that day. And a breakdown of the dollar’s highly negative correlation with oil prices over the next couple of months. Something changed, but it was still unrecognized at the time.
Stage 2: The successful test – This is the pull-back that challenges the consensus view, it represents a significant retrace of the prior wave “self-reinforcing” wave. In the case of the dollar, the pull-back in the dollar index from June 2010 into May of 2001 represented a “successful test.” The move was deep and those who didn’t recognize the trend had changed, or at least weren’t open to that idea of a major cyclical bull market, found themselves on the wrong side of a strong dollar rally over the next several months. In fact the dollar index didn’t make a new swing high until December 2014.
Stage 3: The beginning of a self-reinforcing process – This is the stage where the consensus begins to realize there are real underlying fundamental reasons why this “new” trend has legs. This is the most powerful and longest leg or wave of the trend. We are either late in this stage now, or early in Stage 4. The drivers for the dollar rally now are the usual suspect of the self-reinforcing process; i.e. higher relative growth and yield for the US economy pulling in hot money for yield and foreign direct investment to positon for capital gains.
Stage 4: The growing conviction, resulting in a widening divergence between reality and expectations – This represents the later stage of the major leg or wave of the trend. It is supported by real fundamentals or expectations of how the fundamentals will play out, but it also represents the stage in which the currency is moving into “overvalued” or “undervalued” on a pure fundamental basis (a relative decline in growth and yield differential, for example).
Stage 5: The flaw in perceptions; overshoot and climax – This is the stage in the cycle when some of the major players begin to realize the currency cannot be supported by the fundamentals, as highlighted above. It represents the final stage of the move in the long-term trend, it is the “overshoot” we often see in currency markets as the players tend to become more price-led even as real factors have clearly deteriorated on a relative basis.
Stage 6: A self-reinforcing process in the opposite direction – The trend begins in the opposite direction.
Our forecast from here: a correction lower in the US dollar during the first quarter of 2017; then another major rally pushing us deep into Stage 5 into late 2017 or early 2018 (right on cue for the end of a 10-year bull market in the US dollar .
The Pinstripe and Bowler club shares information with MF Solutions Ltd.