Last week we discussed the current situation in the dollar, which is a waffling above and below what we believe to be a significant pivot price of 113.40 and the impact the outcome will have on other assets. If you would like to revisit, here is a link to the analysis.
We'd like to expand on that topic with some examples of the overwhelming inter-market relationships.
Most Assets Are Trading Opposite the U.S. Dollar
Whether you are speculating in currencies or commodities, or are a long-term investor in stocks and bonds, you are indirectly trading the U.S. dollar. For example, the U.S. dollar index traded on the ICE exchange settles in the opposite direction of the S&P 500, Nasdaq, Dow, and 10-Year Treasury note futures roughly 90% of the time (according to data compiled over the previous 60 trading days).
It is no surprise that changes in the value of the dollar affect the value of respective assets, but the extremely disciplined correlations are likely a byproduct of algorithmic trading programs, overzealous hedging, and momentum speculation -- not the supply-demand or economic fundamentals of the underlying asset.
They say a picture says a thousand words, so we will let charts do the talking. Intraday charts depicting the relationship between the U.S. dollar index futures contract and the E-mini S&P 500 futures contract are almost mirrored images of each other.
On this chart, each price bar represents 360 minutes or six hours; in this time frame, we can see the strong negative correlation across several trading sessions dating to late July.
We see similar behavior in the relationship between the U.S. dollar index futures contract and copper futures.
The chart below also depicts intraday prices using six-hour price bars dating back to late July. Even though the currency market should only partially impact the price of copper, it is behaving as if it is the only factor.
Looking at a daily chart of the 10-Year note compared to the U.S. dollar, we can see the overall trend in Treasuries, and therefore yields, is also highly tied to the greenback. The surge in dollar value from August on has created a one-direction environment in Treasuries (lower Treasuries and higher yields). Only the brief pause in dollar buying in September gave Treasury holders relief.
One More Look at the Weekly Dollar Chart
Friday's close below 113.40 was confirmation that a top in the dollar is not only possible but probable. Of course, in market analysis, there are no guarantees, and unknown information can change the market outlook on a dime. Nevertheless, the wind has been taken out of the dollar bull sails.
In addition to trendline resistance, we see a habitual bearish divergence on the RSI (Relative Strength Index), an oscillator that visually portrays market momentum and helps to identify extended, and often unsustainable, price moves.
When the RSI reaches an extreme high, then makes lower highs as the underlying asset is making higher highs, it is said to be diverging. More often than not, this is a sign that underlying momentum is waning despite extensions in the price trend. As a result, prices are often vulnerable to violent mean reversion.
A recent example of how intense the conclusion of persistence divergence can be is natural gas futures which whipped out 40% of its value once prices started rolling the other way.
Even with the RSI making lower highs on the latest dollar rally, the oscillator on a weekly chart is still near 70, which generally proves to be temporary as prices are prone to correcting with such a high RSI reading. If we are right about the greenback giving up the ghost, a natural target will be near 105.00.
This marks the weekly trendline excluding the excessive valuation that occurred in March of 2020 as Covid shutdowns rocked the globe. However, a round trip to 97.00 is a real possibility. This is the area the dollar index turned from bear to bull in late February of 2022 on the heels of the war in Ukraine.
A weaker dollar would unhitch the plow on nearly all assets, even if all else remains equal. In other words, even if inflation, high-interest rates, and political turmoil persist, many assets can increase in value simply because the dollar loses value.
The obvious beneficiary will be the equity market and Treasuries, but discounted commodities such as the softs (coffee, cocoa, cotton), grains (wheat, soybeans, and to a lesser extent, corn), metals (gold, silver, copper, and energies (crude oil and natural gas).
In short, investors who are long anything other than cash should be rooting for a weaker U.S. dollar.