What does the break out of the US Dollar mean?


Following Friday’s ‘blockbuster’ jobs report on November 6th, 2015, the markets are finally coming around to taking the FED seriously once again. The Dollar Index had enjoyed a steady and a strong rally for the past 18 months, since July of 2014 as the Federal Reserve started to communicate to the markets its intention to wind down the massive Quantitative Easing or QE3 involving purchasing Mortgage Backed Securities and US treasuries to the tune of $85 billion.

The FED’s intention to take away the ‘Punch Bowl’ in the aftermath of the 2008 Global Financial Crisis was met with a lot of doubt, with most of the markets expecting the FED to only come back with more QE. However, as the FED started to slowly wind down its purchases by $10 billion since December 2013, the US Dollar started to rise steadily.

By early 2015, the FED signaled that the era of accommodative monetary policy, which saw interest rates at historical lows, was coming to an end. For most of 2015, the main driving theme was that the FED was going to hike rates this year. The initial deadline was set for mid-2015 or around June/July this year. However, the plans were thwarted as inflation remained consistently low (below the FED’s target rate of 2.0%), while the unemployment rate was slowly but steadily declining towards the FED’s 5.0% full employment mandate.

Friday’s October jobs report on November 6th, 2015 finally saw the FED reaching one of its two goals – full employment – as the US unemployment rate fell to 5.0%. It was a ‘blockbuster’ jobs report due to the mere fact that after a string of two weak months, the average jobs increased by 271k, beating the median estimates.  Also, the average hourly earnings saw a strong increase, rising to an annualized 2.5%.

It was only a few days ago when Dr. Janet Yellen testified last week to the US Senate banking committee that the FED intends to decide on whether to hike rates at the December 2015 meeting if the data supported the view; indeed there was a strong validation from the jobs market last week. It’s a real “live possibility.”

Precious metals and commodities, on the other hand, continued to suffer at the cost of a stronger US dollar as the global economy stepped into a prolonged era of deflation exacerbated by the oil crash in 2014, which saw production outstripping demand and bringing oil prices from above $100 a barrel to near $40 a barrel.

So where do I believe we go from here?  And, more importantly, what is the outlook for the US Dollar now that December 2015 rate hikes has increased in probability?

Points to bear in mind:

  • The FED held off hiking rates in June, and later in September, as inflation remained subdued. Back then the unemployment rate was around 5.4%.
  • There is still one more jobs report to go in November 2015; however the chances that this jobs report will upset the FED’s plans are very low. As long as unemployment rate remains within 5.1% – 5.0% and the average monthly jobs fall below 180k it would still be an ‘OK’ jobs report. In other words, only a worse jobs report (similar to the one seen in March this year) would throw a wrench into the works.
  • Inflation still remains a concern, but the FED is betting on the ‘Phillips Curve’, a theory which shows an inverse correlation between unemployment rate and inflation, and with the unemployment rate at 5.0%, the FED hopes that inflation will start to move.

Technical Analysis – US Dollar Index

The monthly chart for the US Dollar Index (99.15) shows the potential bias staying to the upside. After prices hit the 100 psychological resistance level in March this year of 2015, price closed lower a month later with a bearish engulfing candle. Technically, this should have seen prices move lower, but instead I witnessed a sideways price action for nearly 6 months since April 2015. In the process, the US Dollar Index formed a triangle pattern with the current monthly candlestick breaking out from the range.

Chart 1
US Dollar Index – Technical Outlook

I anticipate that another retest to 100 is in the cards in the near term but I expect to see a pullback towards 97.19 through 96.28, ideally by December. The measured move off the triangle pattern points to two targets of 104.8 which mark the 161.8% move from the triangle’s high to the base and 200% move at 107.53. Incidentally, these two levels mark a strong resistance level validating the move to the upside.

Conclusion: The US Dollar Index is expected to make a pullback to 97.19 – 96.28. If prices hold above this level, the US Dollar Index could potentially break out above 100, targeting 104.8 and eventually to 107.53

Technical Analysis – Comex Gold Futures

On the monthly chart for Gold (1087.70), I witnessed sideways price action for the past three months after Gold posted a strong bearish pattern in July this year, closing at 1094.9. This month, as of last week, Gold broke below the 1094.9 level, but a monthly close below 1094 is needed for a confirmation of a bearish continuation pattern. So, for the moment, the downside bias is neutral.

Chart 2
Comex Gold Futures – Technical Outlook

I noticed a short term resistance area near 1141/1130 while a recent low is formed near 1072. A break below 1072 (on a monthly session) could see the bearish momentum takeover, sending prices to 1042/1030, which marks a test to the lower end of the price channel.

As long as 1072 holds without a monthly close below this level, Gold could see a short term reversal to 1200 above support at 1141/1130. A retest then to 1200 would establish 1200 – 1223 as a resistance level opening up the way to a decline lower below 1072.

Conclusion: Gold prices look to be bottoming for now, but a pullback to 1200 – 1223 is in the cards and the bias remains to the downside, for a break below 1072, which will open up the declines to 1000 and lower. Watch the month end closing prices in Gold, as a bearish close at current level of 1087 could form a shooting star pattern hinting at further downside weakness with no hopes of any recovery above 1141/1130.

Forecasts – Gold and US Dollar

The following are the near and medium term outlook for Gold and US Dollar*.

Nov’2015 Dec’2015 Q1 – 2016
Gold 1130 – 1140 1223 – 1200 1087 – 1000
US Dollar 99.25 – 97.2 97.25 – 96.28 100 – 104

Key Takeaways

  • With the October 2015 jobs report showing the US economy reaching full employment, the FED has no further reason to delay rate hikes. Focus will shift from ‘when’ to the ‘pace‘ of the rate hikes, which will be important. Assuming that the emerging markets do not throw yet another tantrum, the December 2015 rate hike decision could be an almost done deal, as long as the November 2015 jobs report does not disappoint. Even ‘OK’ jobs data in November 2015 is sufficient to keep the rate hikes alive for December 2015.
  • Watch the inflation (CPI and PCE) numbers in the remaining 6-weeks. Even a modest pickup or, at worst, unchanged data is sufficient for the FED to proceed with rate hikes.
  • The US Dollar has historically risen strongly ahead of the FED rate hike cycle and then drops, while Gold tends to fall before the rate hike cycle and then rallies.
  • A key risk to consider is that the FED remains the lone Central bank amongst the developed economies to surge ahead with rate hikes. The New Zealand Central bank went through this cycle last year but the New Zealand economy could not sustain rate hikes resulting in a rather quick cycle of rate cuts. With inflation staying low, the FED will no doubt focus its communication on being as soft and slow as it can with rate hikes in hopes that inflation will pick up sooner than later.

Being on the higher end of the rates will give the FED some breathing space to scale back should the US economy start to show signs of weakening (which starts as soon as Q1 2016 where the US economy generally posts the weakest quarterly growth in economic activity).

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Chris Vermeulen

[Image Courtesy of Wikipedia]


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