$UUP: Reasons to be bullish about the US Dollar


Back on February 8th I suggested here that there was convincing technical evidence that the US dollar was emerging from a basing pattern and that I would expect a steady increase in the value of the US currency against a basket of currencies over coming months. The technical picture is improving although the dollar (and DX futures contract) may be temporarily over bought. The weekly chart for the futures contract shows that there is a clear triangular pattern from which an upside breakout would confirm that the basing pattern has been completed and again from which there could be an enduring (lasting perhaps years) and perhaps vigorous dollar rally.

Several other factors would lend support to the technical pattern and point to a key turning point for the US currency and I shall list them with only minor comments

  • The US was the first in to QE in an aggressive fashion and the underlying economy in the US may be the least ugly sister of the major economies in the world. This would suggest that while the Fed will almost certainly maintain its very accomodative monetary policy the tide may be turning towards a more "normal" policy within the next 24 months.
  • The Europeans have not undertaken any meaningful structural changes to the Eurosystem's architecture despite the relatively calmer conditions for the single currency since Signor Draghi's "we'll do whatever it takes speech" of last July. Macro economic conditions within the EZ continue to weaken and there has been no real progress on the required structural and political changes which would ensure that a currency union has the necessary fiscal architecture to become irreversible as Draghi has claimed.
  • Japan seems committed to a policy of debasing its currency to protect its trade competitiveness - a program at which it may or may not be successful and where the yen will most likely drift downwards unless there is a new systemic crisis at which point its risk off status may re-asset itself.
  • The conditions under which the Federal Reserve will exit its QE policy are looking murkier and, along with others I am beginning to doubt whether there really is a properly conceived exit strategy to unwind the Fed's multi-trillion dollar balance sheet.

    The Fed is now the largest single holder of US Treasuries, the duration of its portfolio is being extended and the hit to its balance sheet from even a one percent rise in long term rates would be considerable - let alone the havoc that could be created as the Fed tries to find buyers of all the bonds that it would need to sell. The likelihood is that at some point the Fed may taper its purchases of new UST's but refrain from trying to unload its existing holdings and allow these to slowly mature.

    While this vital part of the capital markets would therefore continue to be "manipulated" by the US central bank (creating further distortions in price discovery in other asset markets) it would still be US dollar supportive as there would be a reduced risk of having to sell off legacy debt at distressed prices. For these reasons, and for the simple reason that in a more challenging financial environment for other developed markets which seems to be the most likely scenario in the medium term, the US dollar could be embarking on a sustained rally which might stretch out for some considerable period.