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U.S. Dollar: The Ultimate Contrarian Indicator

Last updated 10/12/2009 5:11 PM ET (GMT -5) 6 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: THE ULTIMATE CONTRARIAN INDICATOR
• EUR/USD: HEADING BACK TOWARDS YEARLY HIGHS
• GBP/USD: DOVISH SENTIMENT CONFIRMED
• AUD/USD: EXPANDS CREDIT RELIEF
• USD/CAD: HITS ONE YEAR HIGH
• NZD/USD: RETAIL SALES ON TAP
• USD/JPY: BOJ UNLIKELY TO STIR MARKETS

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: THE ULTIMATE CONTRARIAN INDICATOR

As the U.S. dollar continues to fall to significant lows, more coverage of the dollar’s weakness is expected.  However the fact that the reporting has been mostly one sided in the sense that most analysts believe the dollar should continue to weaken (ourselves included) is certainly worrisome.  On Friday, we talked about how positioning in the greenback has reached extreme levels against the euro which only furthers the case for a near term dollar rally.  Yet the price action in the currency market on this quiet trading day indicates that Newton’s Law remains very much in play – which is that “Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.”  In other words, until the dollar has a good reason to stop falling, it probably won’t.   The dollar traded lower against every major currency today except for the British pound and the Japanese Yen.  

Watching for the Ultimate Contrarian Indicator

Bloomberg and CNBC have been talking about the U.S. dollar throughout the trading day while the Financial Times carried a prominent story in today’s paper about The Case for a Weaker Dollar.  Time Magazine also published an online story about Why Investors Should Bet against the Dollar which indicates that its sharp depreciation has already caught the attention of nonfinancial media.  At this point, we are watching for the ultimate contrarian indicator, which is Magazine Covers.  The curse of the Magazine Cover is something that is often utilized in the stock and commodity markets.  The idea is that once a company or a commodity market makes the cover of a general business publication like the Economist or Business Week, the bull-run is nearly over.  The indicator also applies to the currency market and is in fact probably one a popular method of determining a top or bottom.  In the following chart, we have highlighted that last 4 times that the dollar was featured on the cover of a major magazine.  On March 21, 2005, the cover of Newsweek was “The Incredible Shrinking Dollar.”  Days after the magazine was published, the dollar soared more than 500 pips against the euro.  On December 4, 2004, the cover of the Economist was a story on the “Disappearing Dollar.” Two months later, the EUR/USD fell more than 400 pips and about 11 months later, the currency pair was trading down more than 1500 pips.  The same situation happened in December 2006 and December 2007 when the dollar once again graced the covers of the Economist. Although the rally in the dollar paled in comparison to the 2004 move, the knee jerk reaction still amounted to approximately 500 pips.  The dollar is currently trading at much weaker levels which mean that if the greenback continues to weaken, there is a good chance that we will once again see a cover story about the shrinking or disappearing dollar and when that happens, it will be the “Ultimate Contrarian Indicator.”  For our forex newbies, this means a signal that the dollar could stage a strong rally.

Source: DealBook 360

Columbus Day One Year Ago

In the meantime, the dollar should continue to trade on market sentiment given the lack of U.S. economic data tomorrow.  Markets in the U.S. were closed today for Columbus Day and we take this opportunity to remember the sharp volatility in the financial markets on this same holiday in 2008.  Many people may have already forgotten that on Columbus Day 2008 (October 13), the Dow Jones Industrial Average closed up more than 900 points in a single day as countries around the world rained down with monetary and fiscal stimulus.  Despite the early criticism, their efforts at stabilizing the financial markets and restoring growth have worked.  Many of the same countries have risen out of recession and on this Columbus the volatility in the financial markets have finally returned to normal levels.  

EUR/USD: HEADING BACK TOWARDS YEARLY HIGHS

The market’s appetite for euros remains strong despite weaker economic data. Wholesale prices in Germany fell 0.2 percent last month, which suggests that inflationary pressures in the Eurozone remain soft.  For an inflation focused central bank, the lack of price pressure reduces their urgency to remove unconventional monetary policies.  The EUR/USD is trading within a whisker of its year to date high of 1.4844 and we think that there is a good chance that this level will be tested in the near future. The German ZEW survey of investor confidence is due for release on Tuesday.  Despite the strength of the currency and the rise in the stock markets, we believe that the expiration of the cash for clunkers program and the recent slowdown in Germany’s recovery could weigh on sentiment.  The latest retail sales report was also very weak while factory orders grew at a slower pace.  The Eurozone economy is continuing to expand but we are now seeing the expansion being led by France and not Germany.  A smaller than expected rise in confidence or a surprising drop could drive the EUR/USD back into its 1.4545-1.4845 trading range.  However as long as the currency pair holds above 1.4450, the uptrend remains intact.  

GBP/USD: DOVISH SENTIMENT CONFIRMED

The British pound briefly touched a new four-month low today and unlike the euro remains very weak against the U.S. dollar.  The weakness in sterling is even more evident in EUR/GBP which surged to an impressive six-month high. The pound was slammed today on some new research that predicted the BoE was a long-shot to do anything but add more stimulus. The Center for Economic and Business research indicated that they expect interest rates will remain at their low until well into 2011. In addition, to ensure a recovery strengthens, they see a strong possibility of the BoE adding an additional £75B to their quantitative easing programs, a move similar to what BoE head Mervyn King favored back in August. Putting a definitive time-line on such programs was a shocking realization to some traders that the BoE is the most dovish central bank out of all industrialized nations. Prime Minister Gordon Brown confirmed this title by indicating that now is not the right time to withdraw stimulus as it would derail recovery. These comments are coming as a result of a heated debate between Brown and Conservative party leaders who believe the stimulus should be withdrawn. In any event, stock markets loved the news and headed toward a new yearly high. There were no economic releases today, but we have RICS House Price Balance, CPI, and the DCLG House Prices Index on tap for tomorrow.

AUD/USD: EXPANDS CREDIT RELIEF

U.S. and Canadian holiday’s did not take as much of a bite out of price action as expected. AUD/USD managed to close at a new thirteen month high while the kiwi shed some gains. In addition, the loonie surged higher for the sixth out of the last seven trading days, reaching a new yearly high against the dollar. Another major low in USD/CAD is in sight as the pair continues its downward spiral. As we mentioned on Friday, there is no support for USD/CAD until parity. Commodity prices managed to support the Aussie and loonie’s rallies, as oil gained nearly 2.0 percent while gold circumvents another record high. The Canadian dollar is also still reeling off Friday’s hot employment numbers.  Australian officials announced that they will be expanding support for a residential mortgage backed securities program by about A$8 billion. The expansion, aimed at improving liquidity in the credit markets, comes as a surprise on the back of the RBA’s latest rate hike. Otherwise, news was limited and economic data was nonexistent. Nevertheless, we have more to look forward too into tomorrow. First New Zealand Retail Sales will be released, followed by Australian NAB Business Conditions, and Canada’s New Housing Price Index.

USD/JPY: BOJ UNLIKELY TO STIR MARKETS

Despite a sharp intraday rally, USD/JPY only ended the U.S. trading session marginally higher.  Like Canada, Japanese markets were closed last night for a holiday.  Of all the yen crosses, the most pronounced weakness for the yen was against the Canadian dollar which is not surprising since the CAD also hit a 1 year high against the greenback. On the docket tomorrow are the Bank of Japan’s monetary policy announcement, money supply and bank lending data. At this point, the central bank’s decision is regarded with little excitement by traders. The fact of the matter is that the bank has its hands tied. Introducing any more speculation about exit strategies would send USD/JPY on another downward spiral. Even though several government officials have indicated to the market that interventions were unlikely, another rally in the yen is certainly not desirable. Many Japanese companies have already announced their distress stemming from the yen’s persistent strength. Therefore, the BoJ will make sure that they do nothing to exacerbate the situation. If these conditions hold true going forward, the BoJ decision could continue to warrant less and less interest.

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be the currency pair in play for the next 24 hours. We will have several reports coming from the U.K. including the Consumer and Retail Price Index, as well as DCLG House Prices at 4:30 am ET or 8:30 GMT. The US is set to release its IBD/TIPP Economic Optimism at 10:00 am ET or 14:00 GMT.

The latest drop in the GBP/USD has planted the currency pair firmly in the Sell Zone, which we determine using Bollinger Bands. However, a key level of support lies just below. Drawing a Fibonacci retracement from late-January lows to the August highs yields a 38.2% retracement at 1.5690.  However if prices should turn higher, the most significant area of resistance stands at 1.6125 which capped gains on October 8th and supported lows from September 1st. GBP/USD does not have sentiment on its side so it will take some strong numbers tomorrow to promote a big rally.

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Comments (6)

jacobuzon

October 12, 2009 at 07:41 PM ET

I enjoyed your cheeky "clarification" in response to a comment on your previous article, "For our forex newbies, this means a signal that the dollar could stage a strong rally."
I had a good laugh.

porsche

October 12, 2009 at 11:43 PM ET

now , bad new impact is very poor to $ . i think USD is bottoming .

a_kapoor

October 13, 2009 at 07:56 AM ET

Hey Kathy,
A dollar rally is certainly due, and with the hawkish tone of the Fed seems too imminent. I remember CAD officials talking about intervention when the price was 1.06 or so, but then the CAD data has been surprisingly good. How would you weigh the Fed tone, earnings season and CAD bank-intervention chances at the current moment ?

klien

October 13, 2009 at 09:45 AM ET

We could hear verbal intervention from the Bank of Canada but I do not expect any physical intervention

bertobull

October 13, 2009 at 03:39 PM ET

Thanks for your analysis Kathy. I've more than quadrupled my account by reading your blog and learning from you and ofcourse, using common sense :). I wouldn't pick a bottom for the dollar yet...I'll just wait till it turn. Until then, I'll short it.

klien

October 13, 2009 at 03:41 PM ET

Thats great! Yes, when it comes to forex, its always better to let the currencies turn first before diving in because when turns happen, they usually last

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.