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Sunday, 24 August 2014

US Dollar - Infinity and Beyond?

At the end of the two previous QE periods there have been three strong trends that have emerged each time. The first two are a significant pullback in equities and a strong rally on bonds. We may be approaching a significant high on equities soon, and I have a setup for a major further rally in bonds, though that may well only trigger if we see that strong pullback on equities.

The third is a strong rally on USD, and it's that I would like to talk about today. USD has advanced strongly since hitting 78.93 in May, and I want to show where that is likely to lead over the next few months, and where it might then go over the next few years.

I'll start with EURUSD, which is very important to USD because the Euro makes up an impressive 57.6% of the USD index. EURUSD broke down from the rising wedge from the 2012 low in July, and at the same level broke below the neckline of an H&S targeting the 1.30 area, which would be close to a 50% retracement of the move up from the 2012 low.

There was a decent bounce setup developing on EURUSD with a 70% bullish falling wedge from the high, but as I mentioned a few days ago, that has now broken down with a target in the 1.26 area. I find these patterns to be reliable on downward breaks so EURUSD may well make that target. The full rising wedge target is of course a full retracement to test the 2012 low at 120.42, and that isn't generally a high probability target, though for reasons that I explain below, that target may well be a realistic one in this instance. EURUSD daily chart:
On 15th April, shortly before the May low, I posted the USD daily chart looking at two nested double bottoms that had formed on USD. You can see that here. USD has just made the 82.25 target on the smaller double bottom that I was looking at then, and is well on the way to the larger double bottom target in the 84.25 area. If that target is made then a test of the 2012 high at 84.95 would not be far away. USD daily chart:
What I haven't posted for a year or so is my big picture USD chart from 1980, and I'll post that now with comments on what the short and longer term targets could be for this move. The obvious shorter term target is declining resistance from the 1985 high at 164.72. That's in the 86/7 area at the moment, but it only gets really interesting if that is tested and breaks. If that happens then .....

There are two possible large double bottom setups on the USD longer term chart, and the smaller one has a target in the 105 area on a break over the 2010 high at 88.71. The larger one is so big that it's very easy to miss, but that would target new highs over the 1985 high (at 164.72) on a break over the 2001 high at 121.21. USD monthly chart:
What could possibly prompt a doubling of USD from the current level? Well firstly I'd say that it may not happen, even if the long secular USD bear market resistance trendline at 86/7 breaks up. There is a path back to the 1985 here, but USD may not take that path. However it isn't that hard to see what might prompt such a huge move.

The first reason might be extreme relative weakness in major USD index components. EURUSD (57.6% of the USD index) had a crisis a couple of years ago and is in a very long depression, with Euro-zone GDP still significantly short of the 2008 level. It isn't that hard to see current policies ending in a much larger crisis that could depress EURUSD well below 2012 levels.

JPYUSD (11.9% of the USD index) is the currency of a country in a multi-decade depression, with levels of government debt so high (250%+ of GDP?) that default is really a matter of when rather than if. I called JPYUSD short on 14th November 2012, you can see that post here, and I'd note that the full rising wedge target is a retracement to the 2007 low at 80.55, with JPYUSD currently at 96. From a long terms fundamentals perspective I think that Yen might be an interesting long if it was to reach the 1982 low at 36.04, but I'd have to see a promising setup there, particularly if Japan had not yet defaulted.

So 69.5% of the USD index is made up of two currencies that may go into death spirals due to economic depression and future government default. What else is there? Well there is also the long term chart on bonds of course, and the implications from that are well worth considering here.

I last posted this TYX (30yr bond yields) chart a year or so ago I think, with this amazing 29 year falling channel on 30yr bond yields. TYX is at an inflection point right now, and may retest the lows before we see the move to test channel resistance, but if that channel should then break up in a year or two, breaking the downtrend from the 1980 high, then a further break over the 48-50 resistance level would trigger a double bottom target in the 72 to 77 area. If the two major components of the USD index were at that point still stuck in depressions with ultra-low interest rates, that could make the US Dollar extremely attractive relatively, and fuel a huge move there.

How good is that falling channel as a predictive tool? Well I posted it on 3rd February 2011 as it happens, and you can see that chart here, TYX then made the second high of a double top intraday at channel resistance a few days later on 9th February 2011 and then almost halved over the next year into the 2012 low. A break over channel resistance, as and when we see it, would be something to be respected, and what we have been watching develop over the last few years looks a lot like a long term bottom forming so far.  TYX monthly chart from 1985:
So what's the takeaway here? Well USD and EURUSD may just be starting big moves that may last several years, and USD looks like a buy on any decent dips. I'll be watching these and posting regular updates. The other takeaway is that if we see the big further rally on bonds that I was looking at in the TLT projection I posted on 28th July, you can see that chart here, then when that rally ends it may be the start of a huge decline on bonds (and rise in bond yields) that may play out over decades. I'll be watching for that entry point, and when we see that it may well make my short call on Yen in November 2012 look like relatively small potatoes.

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