The trials and tribulations of dollar bulls are a well honed theme. With the collapse of the dollar, an almost unanimous sentiment, it may be time to think about recovery. A recovery will be the result the Federal Reserve increasing rates when inflationary pressures are feared more than a slowdown in growth and when oil stops surging. These and other factors will become the catalyst for a dollar resurgence. The challenge for the forex trader will be to detect early signs. How can this be accomplished?
The housing sector could provide one of the initial indicators. Housing data for any currency pair, whether it is mortgage debt, housing starts, construction permits, housing prices or others, are leading indicators for the forex trader. The linkage between forex and housing is that when housing prices are rising or expected to rise, central banks have a great reluctance to cut rates, fearing inflation growth. When housing prices are slumping, or expected to decline, central banks obtain breathing room to cut rates because their fear of inflationary pressures is lowered. Mortgage debt financing also plays a key factor in shaping central bank fears. If mortgage debt becomes very large as a percentage of GDP, it means that economic growth is based on highly leveraged capital resulting in instability and undermines monetary policy. The International Monetary Fund (IMF) reports that “residential investments appear to lead the business cycle in many advanced economies, and softening of housing construction may be an important factor leading to a clical downturn.”
This relationship prevails throughout the G8 economies. Today, it is hard to find any statistics that justify being bullish housing. “Falling together” shows the correlation of the Philadelphia Housing Index and the U.S. dollar.
Yet there may be another force emerging to rescue the dollar: housing affordability. With prices significantly lower, at some point the opportunity to buy an existing or new home will have increased appeal. Of course for those housing flippers who now have to hold onto inventory, lower prices are bad news. But for new entrants into the housing market, there may be bargains soon. We are not at that point yet. But traders should begin to monitor housing affordability indexes that may show the recovery handwriting on the wall.The Housing Affordability Composite Index (HACI) and the report on housing affordability for first time homebuyers are reports to follow. A 100 reading on the HACI indicates that an average family can afford the median price of a home (see “Looking up”). The National Association of Realtors produces these indexes.
We can see in the HACI that market forces are beginning to work. This doesn’t mean that the housing market has bottomed out, but it does mean that bottom fishing is occurring. Increased affordability translates into increased demand and demand translates to decreased probability of further rate cuts.
The housing collapse may have started in the United States but it’s viral in nature and has spread to Great Britain and beyond. Forex opportunities can be found by monitoring global housing statistics.
Based on affordability analysis, a dollar recovery may not be far off. Keep a keen eye on housing markets.
Abe Cofnas is president of FXdimensions.com and provides forex coaching as head forex coach at SecretsofTraders.com. He can be reached at abe@secretsoftraders.com