If you get the dollar right, you will get a lot of things right. Hard-lined policy in Washington has created a safe-haven flight to the dollar. Trade policy and sanctions have resonated an uncertain atmosphere for growth in many areas of the world. Furthermore, countries such as China who are at the center of a trade dispute with the United States have allowed their currency to weaken in order to combat the cost of tariffs. All the while, strong U.S. growth and the Federal Reserve’s path of tightening has been priced in since March and real rates have not risen. This highlights that the Dollar’s strength is, in fact, the underlying weakness of its peers.
Given that China is the world’s second largest economy, the Dollar Index, which is 57% the euro and excludes the Chinese yuan, is not a great gauge of the Dollar’s broad picture. Still, the Dollar Index lost 15% from the high in January 2017 to the low in February 2018. Also, thedDollar lost 10% against the Chinese yuan from the high in December 2016 to the low in March 2018. At Blue Line Futures, our longer-term belief is that the Dollar will resume the downtrend that began after peaking in the first week of 2017. It is also important to understand that nothing moves in a straight line and while we hold this belief, we have certainly not pounded the table on being short the Dollar during what has been roughly a 10% rally from each of the aforementioned lows. There have been moments that we said the dollar must close below a certain level to encourage a top or the Euro must close above a certain level to encourage a bottom; none of which occurred. There have even been moments where we called for the Dollar to strengthen further and the Euro to find a path of least resistance lower. This is because we understand that nothing moves in a straight line and to further that point, we must see a true setup in order to recommend taking a position and not simply hold a longer-term bias.
This now, is more than just a moment, this could be the pinnacle of the dollar’s safe-haven flight. The euro is the most liquid and highest volume currency contract against the Dollar so for the purpose of sentiment, it is a great indicator. The majority of our references to the CFTC’s Commitment of Traders in the past has focused on Managed Money and Leveraged Funds. Today will be different. Commercials, who hedge currency risk in the Euro carried a net-long position beginning in May 2014 and did so until May 2017; long at the top until it bottomed. Commercials turned net-short in May of last year and continued to build shorts to a record of 192k contracts when the Euro was at its height. Commercials are now at the lowest net-short position, 10k contracts, since that week in May of last year in which they turned net-short with 33k contracts. That week in May was the French election, a true fundamental turning point for the euro.
Last week, the Euro traded to the lowest level since June of last year and tested a crucial level of support before reversing more than a penny (chart below with trend line). The Yuan traded to the weakest against the dollar since January of last year when the Dollar peaked (chart below) before finishing 1% off the highs. While there may not be one single event to identify this as a turning point like the French election last year, on Friday there was the first glimpse of an end-game in the trade standoff between the United States and China. It was reported the two sides have plotted a roadmap to resolve their dispute in November. This will gain traction in an already busy week; low-level delegates from China will meet in Washington on Wednesday and Thursday to discuss further. Ultimately, this meeting is to officially delay the announcement and implementation of $200 billion in tariffs on Chinese goods in September; this, if implemented, would be the official start of a trade war.
The dollar is under the microscope and the question is whether the euro and yuan after finishing Friday 1% from their weakest levels in at least a year is the start of the next turning point. We now must believe so, however, traders must be cautious if the United States and China talks deteriorate.
Key events to watch for this week are:
- The German Bundesbank releases a monthly report on Monday morning
- FOMC Minutes from August 1st meeting are released on Wednesday at 1:00 p.m. Central
- Minutes from the July ECB Meeting are released Thursday at 6:30 am CT
- Flash PMI’s from Europe and the U.S are due Thursday (preliminary August reads)
- U.S Durable Goods data is on Friday
- Jackson Hole begins this week and Fed Char Powell’s keynote speech on “Monetary Policy in a Changing Economy” is Friday morning at 9:00 am CT.