The US dollar is arguably the most important asset in the world. As the primary driver of global macro trading, and investment flows for commodities and equity markets, it should not be ignored by investors (regardless of whether or not you trade currencies). Gauging the direction of the greenback is therefore vital to your success.
If one could predict the direction of the US dollar, then making money would be effortless. Whilst it is never that easy in trading, our currency checklist shares with you the process that Lex and I present at our Trading Club based on our experience as professional investors.
Here you see our checklist applied to the US dollar. The checklist provides a similar process to that followed by many of the best hedge fund managers and professional traders to analyse markets. We have similar versions to assess other major currencies, stock markets and commodities including crude oil and gold, and score each factor +1, -1 or 0 depending on whether they are positive, negative or neutral for the coming month. A positive total score indicates a potential buying opportunity, and a negative score suggests that you should look to sell (closing long positions or going short). A neutral score of 0 suggests avoiding trades when there is no clear bias.
Country analysis. Here we see only green in our country analysis scorecard this month, indicating expansion in the US economy. This receives a positive score on our checklist. (+1)
Economic surprise. The United States Citi Economic Surprise Index (CESI) is also improving, with an increase of 25 points this month. Whilst still below zero, against the improvement seen in the realised data captured in our country analysis scorecard this suggests that economist estimates have been slow to revise their estimates upwards and are overly pessimistic. Put simply, the data have been beating expectations, which is a positive on our checklist. (+1)
Real interest rate. The difference between the US 10-year government bond yield and US CPI inflation is negative (-0.5%). This is means that domestic savers and foreign owners of US dollars are losing money by holding cash. Whilst the Federal Reserve has commenced with successive rate hikes, the real rate remains negative for now along with the majority of G10 peers. (-1)
Futures positioning. We view speculative positioning as contrarians. Futures traders are now net short the US dollar index (DXY), meaning that they are positioned for a continued decline. Whilst the absolute level is hardly extreme, on a relative basis the positioning has come a long way since the net long position peaked and began to be unwound. We consider this a small positive as contrarians, and would award a full score should this net short become more extreme. (+0.5)
Technical analysis. Looking at the chart, the technical picture at first appears pretty bleak. However, on a weekly basis the US dollar index is technically ‘oversold’ according to the Relative Strength Index (RSI), which suggests that the negative momentum may be expected to slow, and possibly provide opportunity for a technical bounce. However, the bottom end of the 2 year channel has been broken, which doesn't support this idea, unless in fact it proves to be a ‘false downside break’ which technicians such as myself would consider to be potentially very bullish. On balance, we award a small negative considering the combination of poor price action with an extreme indicated by our technical studies. (-0.5)
In total we arrive at a score of +1 heading in to September, which is a reversal from the negative score previously seen in recent months. Our checklist provides a reference for what we should be looking to do as investors in the month ahead - and is based on facts, not opinions. This suggests turning from a negative to a positive bias on the US dollar during September.
Hopefully this offered useful insight in to what is happening in currency land, and the likely impact on other markets. Regardless of whether you see yourself as a currency trader, all markets are influenced by currency factors and investors in stocks, bonds and commodities have implicit currency exposure whenever they trade.
Join us at the Academy to ensure that you are on the right side of the market and apply this same process to stocks, gold, crude oil and other currencies with analysis from myself and Lex van Dam.
Have a great week trading!
Join James Helliwell and Lex van Dam and receive a full analysis of equities, currencies and commodity markets each month as a Trading Club member.
Disclaimer: Our service is intended for educational and informational purposes only and should not be considered investment advice. Do not make any decisions based on the articles and material presented on www.lexvandam.com and never trade with money you cannot afford to lose. We cannot be held responsible for your trading results.