It is now over two years since the financial global collapse of 2008. The collapse was so great that it was calculated to be more than 11 standard deviations from the average value of the Bloomberg U.S. Financial Conditions Index. To put that into perspective, we need to remember that three standard deviations from an average usually captures 99% of price variation around an average. The deviation from normal because of the financial collapse was, therefore, tectonic in its proportion.
The result of the shock was the onset of a deep disconnection and shift between ongoing expected fundamental forces shaping forex prices. Before the financial collapse, the key driver of forex price was interest rates and expectations regarding changes in interest rates. In normal times, central banks — the Federal Reserve in the United States — use interest rate increases to dampen inflationary pressure and decreases to try and boost economic activity.
However, with the financial collapse and the collapse of the housing bubble, interest rate decisions of central banks, here and globally, became a moot point as a multi-year era of low rates resulted. During the recent great recession, the contraction of liquidity and GDP nullified the usual concerns about inflation for the Federal Reserve. As a result the Federal Reserve unleashed a massive monetary expansion. But the financial storm appears to be lifting and the inter-market patterns of the U.S. dollar and the U.S. economy are beginning to shift. There is evidence that the post-2008 global dynamic is running its course. However, a "new normal" era may be occurring, and with it a new set of opportunities in U.S. dollar and inter-market trading.
The case of the U.S. dollar movements in relation to the housing sector is such an example. Prior to the fall of 2008, we can see that the housing sector and the U.S. dollar experienced very close movements. After the collapse, the U.S. dollar oscillated in large swings, primarily acting as a safe haven basket.
But there is evidence of a possible bottoming out of the housing market. KB Homes (KBH), a housing equity, and the SPDR Homebuilders ETF (XHB) are signaling the worst may be over (see "Is this the bottom?"). They can be a leading indicator for underlying support for the U.S. dollar. If sentiment begins to indicate better housing conditions, this will lead to expectations for a tighter monetary regime. It doesn’t mean that there has to be an increase of interest rates; just the expectation of a better housing sector could shift sentiment in the market and at the Fed that interest rates should rise to head off inflationary concerns. One of the factors missing to date on inflationary concerns has been the housing market. A bottom in the housing market correlates to greater pressure on prices as the demand for lumber and other resources are drivers of the housing market. In fact, with commodity prices rising sharply across the board, you can argue that housing is the only thing keeping the Fed from changing its low inflation outlook.
All this flows into an upcoming bullish scenario for the U.S. dollar. An overlay of the dollar index against Plum Creek Lumber (PCL) and lumber futures (LB) shows that their movements have been pointing to increased demand for lumber for the past two years and, with it, implications for a stronger U.S. dollar (see "Wooden nickel"). Lumber is closing in on previous resistance and a breakout would be an important fundamental shift in demand.
While we can’t pick tops and bottoms in markets, the inter-market relationship between the U.S. dollar and, in particular, the lumber market, are pointing to an emerging bullish condition for the greenback.
Abe Cofnas is the author of "Sentiment Indicators" (Bloomberg Press). He can be reached at abecofnas@gmail.com.
