Dollar Free Ride

By Ryan J. Puplava CMT, March 29, 2010

The U.S. dollar has enjoyed a free ride since Europe’s economic troubles with Greece. Sovereign debt downgrades had encouraged assets to begin leaving the European region causing the euro to drop. The euro zone’s current account balance fell pretty strongly in January. The balance fell to a deficit of 16.7 billion euros (unadjusted) from a revised 9.8 billion euro surplus in December. Representing 57.6% of the U.S. dollar index, the euro has helped cause the U.S. dollar index to rise from 74 in December 2009 to a high last Thursday at 82.24. This represents a retracement of 50% of the U.S. dollar’s drop since March 2009.

Greece’s budget deficit had reached 12.7 percent of gross domestic product in 2009 according to Bloomberg. With a number of downgrades on Greece’s debt rating, Greek bonds risked losing their eligibility as collateral at the European Central bank (ECB). Credit default swaps began rising to crisis levels and predatory funds began seeking other prey in Portugal, Italy, and Spain.

Credit Default Swaps

Source: Bloomberg

Last week, European leaders agreed to a proposal that would mix loans from the International Monetary Fund and loans from each euro-region country based on its stake in the ECB. Most of the loans would come from Europe. The proposal is only to act as a last resort should Greece run out of capital raising options.

Today, Greece offered seven-year bonds at a yield nearly five times the premium of similar Spanish bonds. The bond issuance would raise 5 billion euros. According to a Bloomberg article, Greece “must raise 53 billion euros this year, 15.5 billion euros of it by the end of May”. Greece’s ability to finance its funding needs throughout the rest of the year may still weigh in the balance, but the IMF and ECB backing is a step in the right direction to shore up financial stability in Europe.

The U.S. dollar’s rise is namely a euro phenomenon

If you look at the U.S. dollar’s other relationships, the rally loses less of its significance. Since the U.S. dollar index began rising in December, the U.S. dollar has been relatively flat versus the Japanese Yen (13.6 percent of the dollar index).

Over the same time period, the U.S. dollar has lost 3.4 percent of its value versus the Canadian dollar (9.1 percent of the dollar index).

Looking at another commodity-led currency like the Australian dollar, we can see that the Australian dollar has also been flat versus the U.S. dollar since December 2009. A flat Australian dollar is no small thing after rising nearly 50% versus the U.S. dollar since March 2009.

With credit defaults swaps falling in Europe and Greece shoring up its funding needs, the rally in the U.S. dollar index may be nearing a top for the time being. One of the first signs I look for in a reversal is a divergence between the Relative Strength Index (RSI) and price. Divergence occurs when price reaches a new low or high but the RSI does not. Looking at the U.S. dollar index, I can see some bearish divergence between peaks in the RSI during February versus now. Another warning sign of a possible trend change I like to look for is whether price can reach trend channel extremes. We can see here that the dollar looks to be reversing short-term without reaching the top of the trend channel.

Elliott Wave analysis is another form of charting that can help see the forest for the trees. Generally, the direction the market wants to move unfolds in 5-wave sequences (3 actionary waves in the direction of the trend divided by two corrections). Since the U.S. dollar index has risen to a new high in March, we can tell that the current move in the dollar has established at least 5 waves. There’s a possibility for an extension (like last year’s move in the dollar down) but that typically only happens in rare occasions of intense momentum. Once a motive mode finishes (five waves in a relative direction) then a corrective mode sets in. If wave 5 has topped here, then the U.S. dollar could be looking at a corrective mode straight ahead.

There are a number of “green lights” on the U.S. dollar that still hold bullish conditions that remain until broken. As each indicator reverses, a trend reversal will be made more credible.

• The bullish trend channel is intact since December
• The RSI is in a bullish shift until it caps at 60 and confirms a reversal with a break below 40
• The 13 versus the 34 exponential moving averages have not crossed into a sale yet
• The 50-day smooth moving average is rising below price
• The 200-day average is now rising
• MACD is positive

While the dollar has rallied in the past four months, it is largely a euro phenomenon. That phenomenon is based on a sovereign debt crisis concerning Greece’s ability to refinance its debt. For now, that crisis is beginning to wane as credit default swaps have dropped since February 4th, but Greece has a long road up ahead to refinance 53 billion euros in debt. It would be a good idea to continue watching Greece’s debt issuance throughout the year and the resulting affects on the U.S. dollar index if you’re invested in dollar denominated commodities, such as gold, that tend to fall when the U.S. dollar is rising.

Ryan Puplava

© 2010 Ryan Puplava

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Ryan J. Puplava CMT
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