The Game to Watch Tonight is Not On TV

It is on the Forex screens. Turn off NBC or Fox and tune to FX. Will there be a Dollar Dump tonight? Or is a Dollar short squeeze on? 

A few days ago I speculated:

Throughout November we have seen overnight selling of the USD Sunday, and a sharp spike up in equities Monday; then a fade through the rest of the week. Given Thanksgiving and Dubai, the pattern reversed into a sharp overnight drop in equities; but the pattern returned on the last day of the month, with overnight dumping of the Dollar on Monday night and a sharp rise [in equities] to greet the new month.

Why this play? A number of Asian Tigers publicly announced that they would intervene to debase their currency (or at least stop it rising so fast against the USD) in order to remain price competitive with China. China stayed out, Japan is tapped out, and the US stayed mum. If you were George Soros, who had called a bluff of the Bank of England and won, what would you do? Sell into them, let them drive it back up, and do it again! In the meantime hedge via buying into US equities. I cannot confirm the play, but it is pretty clever.

The overnight Dollar Dump begins Monday morning in Sydney, and then spreads towards Europe with the rising sun. Australian markets are open, and the AUD has fluctuated, being slightly higher right now. Japan just opened, and the Yen is also slightly higher (vs the USD). The US Dollar Index is fading right now, down a little. Hard to extrapolate so far. We have to see what Europe begats.

The choice of Dump vs Squeeze will have a huge impact. The denouement may not happen tonight, but tonight will give us a clue. There is an estimated $1T in the Dollar Carry Trade, meaning (simplified) borrowing in USD and lending (buying bonds) in another currency. The darling right now is the AUD, since the Oz government has been increasing rates. Borrow in Dollars at 0.25% and buy the AUD bonds at 3.25%. Nice spread, especially if the USD continues to fall and the borrowing can be paid back with cheaper Dollars. 

But what happens if the USD spikes up? Those near-zero interest-rate debts have to be covered with more expensive Dollars, creating a potential loss that dwarfs the rate spread. If you don't have the inventory of USD accounts to cover, you have to race into the market. Banks of course have all sorts of swaps between currencies, but swaps have time limits (like CDs) and other limitations that still require covering at a higher cost.

There are several events that argue for a reversal of this pattern:

• The sharp spike up in the USD Friday bespokes a short squeeze
• We hit record lows on 2-yr Treasuries after Dubai, and although have eased off this, it suggests a return to risk aversion could happen quickly
• The Japanese may be tapped out - there is a story that Japan may stop buying Treasuries. See chart. A major speech is expected today in Tokyo, tonight in the US. 
• The $1T carry trade would suffer huge losses with a Dollar spike, and need to move quickly to cover their short positions (short the USD) if it occurs

 

My take is that the Draconian scenarios like Japan backing out of Treasuries are not an immediate policy change. We might find out differently tonight! Yet absent a crisis these changes tend to ease in and the market rolls over, not spikes. 

Think like a carry-trade bank or hedge fund: would you back down your play over a vague set of statements out of Japan and a one-hour pike in the USD? You have $1T in play, and can probably quickly add another $0.5T. This magnitude dwarfs the currency intervention of the smaller countries; no need to fear them. The US has signaled as clearly as it can that the Fed is not prepared to intervene to support the USD; indeed US policy is to allow a controlled fade to support low interest rates. Is Japan really about to intervene at scale to drive the Yen down? Well, maybe, but let's wait and see if they actually do it first. 

If I were playing currency poker, I might back off a week and see what happens, then hammer the trade again next week. But it has worked so well so far despite jawboning, why not continue pressing? 

At some point the Fed will have to support its currency. The US is under huge pressure from Europe and Asia to stop their reckless monetary policy. The FOMC now seems to have dissenters of Bernanke's policies, and Bernanke is having to fight for re-appointment.The well-respected economist David Malpass put forth his case for raising rates over the weekend. David's comments are priceless:

The irony of the zero-rate policy, coupled with Washington's preference for a weak dollar, is a glut of American capital in Asia (as corporations and investors shun the weakening U.S. currency) and a shortage at home. ...

According to International Monetary Fund data, U.S. GDP has fallen to 24% of world GDP from 32% in 2001. And as U.S. capital escapes the weak dollar and high tax rates, the U.S. share of world equity market capitalization has fallen to 30% from 45%. This leaves the U.S. alone with Japan at the bottom of the monetary heap, with rate expectations so low they repel investment. ...

The fed-funds rate can stay near zero for a while longer, but the Fed can't keep promising "exceptionally low rates for an extended period," as it did last month. 

David thinks a change of policy may come at the Dec16 FOMC meeting. The apparent peak in unemployment gives political air cover for the Fed to shift. He expects Wall Street to throw a tantrum (ie equities to drop) if this occurs, but it will do more for righting the global economic situation than a steady drop in the USD. So perhaps the fun is not tonight, but in two weeks. 

Comments

[joe]

I think that usually the dx starts really dropping off by now. You are right to watch for the European open but really euro,gbp aus are all pretty flat. Yen is bouncing somewhat (not surprising considering friday) - but it is not having too much effect on dxy.

Another really good post Yelnik. It will be telling tonight if the dollar does not give back most of fridays gain - I think.

Joe

[joe]

I am noticing Dow futures keep drifting lower. Its dropped about 30 points since trading started in Asia.
I am also coming to the conclusion that at this point, if the dollar was going to give back most or all of its friday gain, it would have done it by now. Yen looks pretty solid to me at that 89.78 low and has been coming back since it made it a few hours ago.

All in all - I don't think there will be the "monday rally" this time.

[Roger D.]

Yelnick,

Great post,

I often wonder what leads what in direction the USD or the S&P.

Here is my intpretation of the move up from the November low, I was using Tony C's 60 minute chart of the SPX.

I reviewed Tony's new count and to me the count is clear as a bell now. I know I stated that EW was confusing up here, but no longer. Looking at the S&P 60 minute chart starting from the November bottom, and I contend this is the final wave thrust to the top of primary B or P2. From the 4 we have 4 waves up for minor wave 1(1113.69) then minor 2(1086.81)then minor 3(1112.38),then minor 4(1083.74) and from that point we start the final minor wave 5. This wave took the form of 1,2,3,4 and then extended in a xa,xb,xc,xd,and the final exhaustion xe.

The wave up from B is now 11 waves and complete by my interpretation. I expect either a mini or maxi crash out of this pattern. The only time I have seen a extension like this in a major average was 1987,1990 in the transportation average in 1990 and the EDT pattern in 2007.

This pattern is a 5 point reversal where the final extension took the form of a 5 point reversal also. In other words we have a broadening top.

As far as the other averages, and world averages, to me they all topped Friday in unison as well as gold and the USD reversed and has put in a significant bottom.

The top in the S&P is so perfectly formed I can't imagine it , not to be of a historical nature. Cheers,
Roger

[yelnick]

Roger, Tony is very good at what he does, and is the steadiest hand out there. EWI has two counts, one like Tony C but the other makes the fall into Nov2 (what Tony has as wave 2 of C in his Dow count) an X wave.

If we reverse form here, the prime reason will be a sea change in the easy money of Bernanke to a gradual tightening - his exit strategy will have begun. It may be because of huge pressure behind the scene by the ECB, the Japanese and the Chinese.

[joe]

This is on Bloomberg now (clip)....

Takenaka said the decision by the Democratic Party of Japan-led government to replace the country’s economic advisory panel with a national strategy bureau has made decision making “messy.” He said the smaller coalition members have “very strong bargaining power” and may succeed in increasing the size of the stimulus package.

Hatoyama had been preparing spending of as much as 4 trillion yen ($46 billion), Finance Ministry officials familiar with the matter said last week.

Chief Cabinet Secretary Hirofumi Hirano said today that the government is “putting on the finishing touches” in time for the package to be considered by the cabinet tomorrow.

Yelnik - The guy is a politician. I think he wants to keep his job - and will do what he has to to keep it. He has about seven months to come up with something and make it work. He has to knock the Yen down - and make the benefit flow through that countries economy all in that window. That is why I am guessing his attack on his currency is likely to get tough.

Joe

PS - pound just went negative to dollar.

[John Smith]

The FED will not raise interest rates to the point where it really matters. How could they? The Treasury is financing most of its debt short term. If they raise interest rates to just 5% it will mean an other 200 to 400 billion in interest payments or 2 to 4 Trillion over the next 10 years. That would put us well over 20 Trillion by 2020 just at the time when all the other bills start coming due. I just don't see how this will continue for much longer. Eventually the can will run out of street.

[joe]

(The above is what I clipped from the end of the story)

I do think we are going to get a "sharp pull back" shortly, probably starting tomorrow, that will pull the Dow back to the bottom of its ascending channel. That is at about 9900 +/- now. It could rally after that into the end of the year - or not. But I do believe it will do this 400+ point pull back this week.

Is this about what you are getting as likely?

Joe

[Tom CZ]

EURUSD breaking 1.4800 - 1.4825 area - thats where March - Dec trendline sitting now (stops made it for themselves) - dont buy the dip as this may mean turn in market thinking although not recognized officially yet. Should accelerate soon. Tom CZ

[cloudslicer]

I think there is a potentially bullish count on the Nikkei. Could the 03/09 lows mark the market bottom in Japan and the end of the secular bear?

I know that Japanese consumers are sitting on mountains of cash (I think its 12 trillion). If they can spur consumer spending look out!

Is a count from 03/09-09/09 on the EWJ valid as a wave 1? Obvious implication is that we are starting a 3rd wave up.

Looking at a weekly chart of EWJ:

http://stockcharts.com/charts/gallery.html?EWJ

A break above 10.38 should lead to an explosive move up.

[coleman]

great post

[da bear]

I just posted this on my message board regarding gold and my wave count of it:

Gold's B wave run up may be over. this move down looks and feels impulsive.
so this would be the first part of the C wave down.
i would guess that gold is short-term oversold so a quick bounce could happen soon.
then another move down.
Prechter's Theorist had gold in a B wave that met a top trend line. Ha. his wave count looks like mine, but i probably put mine out first! Laughing
a C wave down would then hit the lower trend line from that Theorist. i truly believe that it would be a higher low (higher than the low last November).
then after this wave C of II of Super Cycle V is over then we get the primary wave I of Super Cycle wave V up in gold. which should be fun.
to give you a perspective on the long-term count in gold i am counting the move off the 1932 golden low of around $20 as Super Cycle I. the fixed price until 1971
then was Super Cycle II. the golden move in the seventies that took gold from $20 to $100 then to $200 then back to $100 before the launch to $850 was Super Cycle III.
the long-term correction from 1980 to 2000 (marking the entirety of the Kondtratieff Fall) was Super Cycle IV. so now we are in Super Cycle V. this will end in World Gummit and the last
K-Cycle Winter of All Time. the price of gold will match the run-up of the strongest of stock markets (China?). on a broader scale it will be a part of a Grand Super Cycle B (looking less likely),
or more likely, it will be Wave 4 (the last corrective rally in the history of mankind as we know it) of Grand Super Cycle C down. yes, Prechter was wrong because he misunderestimated the severity of this bear market. this is the bear market to end all bear markets. it will end with the rapture. See the book of Revelation. so after this next wave down is over then we get an absurd sucker reflation rally. look for completely bizarre bull markets mini-manias to flourish. Like tulips or what have you...

da bear

P.S. I am always thinking about what the worst case scenario could be. well here is one: a stock market crash for Christmas.

[joe]

"I think there is a potentially bullish count on the Nikkei."

I agree - and it makes sense. Their exporters will do well as the Yen drops.

Joe

[joe]

Yelnik -

Maybe you can do a post on the strange action in T-Bonds (the yield holding up, the equities (holding up, so far) all while the dollar keeps getting stronger (at least not getting dumped).

I don't think any of these forces happening together make sense at all. I know the dollar up/equities up phenomenon has only been for a couple days - and may be a flash in the pan - but it is strange none-the-less.

What do you make of this?

Joe

[vipul garg]

why is one in every two post by 'joe'!

[Bird]

why is one in every two post by 'joe'!

I think they are twins

[vipul garg]

i was begining to think that the rules have changed and one needs to sign in as 'joe' to post!

[Joe Bird]

that's silly.

[joe]

Sorry if I posted too much on this subject.

Joe

[vipul garg]

atleast now one in four posts are by'joe'.

maybe, in elliott terms, joe posts 'corrective' phase has started after the blowoff.

[yelnick]

Joe, Bernanke just tried to talk down the Dollar reduce expectations of a rate rise soon. So markets are digesting. The WSJ's take is that after the speech, both Tech and Financials were down even as the broader market was up. When the leaders fall, change is in the air. After a pause, equities have now taken a dive. Maybe their digestion of Bernanke's remarks has led to heartburn? 

[Brian]

So, are there any predictions on if/when DXY will cross 77... 78... 80..! or 70?
As for me, I am guessing it will go to 78 by the end of the week?