Bearish dollar setiment getting extreme
We have seen a big decline in the dollar over the last 6 or 7 months. That was exactly what I had been predicting and I still believe that the trend for the dollar is lower, however, at the present time we may have reached a point where we can see a counter trend rally in the greenback.
The reason I believe this is twofold. First of all short positions in the dollar are now running at extreme levels. For example if you look at Japanese Yen futures that are traded on the CME, we now see that speculators both large and small are net long in futures at the highest amount in four years.
Highest long yen futures position in four years.
This is similarly true with some of the other currency contracts traded on the CME as well. In other words people have been buying currency contracts or, as we would say it in spot terms, they are shorting the dollar against some other currency. We have definitely seen the sentiment swing very sharply from what it was a year ago.
The Fed is holding off
The second reason I think that the dollar can be in for somewhat of a rebound has to do with the Fed. Let me first back up a bit. The reason I am bearish on the dollar generally is because back in December the Fed started to hike interest rates after a nine-year period when there were no rate hikes at all.
Rate hikes are bearish for the currency. This is contrary to how most people view right hikes. A rate hike is a price increase and a price increase is inflationary. Exchange rates reflect rates of inflation. If inflation is rising then the exchange rate of the currency in question is marked down. In other words the purchasing power of the currency is reduced. The currency buys the less.
This is exactly what happened following last December's rate hike. Since then we have seen a very significant decline in the dollar. If you look at the dollar Index it was up around 100 right before the Fed raised rates and now it's down around 94, which is about a 6% decline in the value of the dollar.
On the other hand there is a growing feeling that the Fed will not hike rates any further or, that it will be much more cautious or slow in terms of its rate hike agenda. The Fed itself has also been sending out that message. Janet Yellen has been giving speeches alluding to the fact that the Fed intends to move more slowly than originally planned.
This is why I think in the short-term the dollar sell off has been fully discounted. We now have to take into account the fact that the Fed could be on hold. Personally, I do think we will see more rate hikes, most likely later on in the year, however, for now market participants and the Fed believe that’s on hold.
Dollar set to fall, longer term
Ultimately this period will resolve with the emergence of stronger economic data. The reason I say this is because the spending flows have been very, very strong.
That's the final point I would make here. Stronger spending flows mean that foreign exporters will regain some pricing power and that is another way of saying a lower exchange rate for the dollar.
For now it's probably wise to anticipate a counter trend rally over the next several weeks maybe months but ultimately the dollar will head lower later in the year and I suspect that by December it will be significantly lower, probably down around 91 in the Dollar Index and probably down around 1:06 dollar/yen.
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