Thursday, October 23, 2014

Dollar Could Strengthen by 8% on Global Repair

The U.S. Dollar is showing a little strength this morning and that follows a strong performance over the last two sessions.  Yesterday, the dollar index (DXY) broke above a trend line that defined the 2.6% pull-back from the 4+ year old high.  That pull-back held a rather defined trading band that could be interpreted as a flag in a bullish flag formation.  The objective of this bull flag would be about 92.45, a level not seen since 2005, when the U.S. last saw outsized economic growth.  2005 was of course also a time when the Fed was at the heart of its ‘measured pace’ campaign of removing policy accommodation.

Many believe that equities cannot advance in a bullish dollar environment.  S&P’s are currently 1.4% higher and some might think that either the dollar or the S&P ‘have it wrong’ today.   It may have been more true in years past that a strong dollar had a bigger impact on equities than is the case today.  As our friends at GS have recently pointed out (US Daily: Weak Global Growth Is Not a Big Threat to the US Recovery (Hatzius/Mericle), only roughly 13% of U.S. GDP is comprised of exports.  As such, it is not so necessary to have a weak dollar in order to see higher equity prices.  Nor does a mildly weaker Europe necessarily mean a mildly weaker U.S.. 

Finally, the Flash PMI out of Germany today may have counterintuitively relieved some of their worst fears that the Eurozone economy was destined to wallow in recession.  The concern was that a weak Europe would drag the U.S., at least temporarily, away from its ‘destiny’ of stronger growth and thus keep the Fed from normalizing in a timely manner.  Increasingly, it looks like the economy is in good enough shape that consensus will reshape toward seeing a mid to Q3, 2015 beginning of Fed normalization.  This should provide support for the dollar.  An 8% advance, as is projected by the DXY 92.45 bull flag objective seems a little excessive, but not something we haven’t seen before.   

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