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Buy the U.S. Dollar: Central Bank-Fueled Dip Will Be Short Lived (UUP)

July 05, 2014 | About:

Recent monetary policy meetings at various central banks around have led to massive downturns in the US Dollar. The latest example of this was seen with this week's interest rate decision from the Bank of Japan (BoJ), which was a relative disappointment for traders bearish on the Japanese Yen. The currency is now seeing gains against all of its 16 most commonly traded counterparts, as expectations that the central bank would enact measures to calm volatility in Japanese bonds were proven incorrect. The main take-away from the central bank meeting was that the BoJ sees no immediate need to extend the maturities in private bank loans, and the knee-jerk reaction in the markets was to reverse short Yen positions, sending the USD/JPY to its lowest levels since April.

BoJ Policy Meeting

In ETFs, this translates to substantially bearish moves in PowerShares DB US Dollar Index Bullish (UUP) and highly bullish moves in theCurrencyShares Japanese Yen Trust (FXY). The BoJ left policy unchanged, with no stated plans to alter the 60 trillion Yen ($611 billion) in annual injections to the country's monetary base. Most analysts were expecting the BoJ would approve loan operations that extend to two years (or longer), and the results put renewed focus on the 10-year Japanese treasury note. Since the BoJ announced its historic stimulus plan in April, the 10-year note has risen from its all-time lows at 0.315% to highs of 1%. The main ideological thrust of the BoJ must be kept in perspective, however, as there is still clear long-term concern for the prospects of the country's export companies and pronounced efforts in place to bring consumer inflation levels back toward normal ranges.

ECB Policy Meeting

Elsewhere, similar market reactions could were seen after last week's monetary policy meeting at the European Central Bank [ECB]. The ECB also did little to signal changes to its own stimulus programs, which was not a total surprise, given the fact that the bank reduced interest rates by 25 basis points to new all-time lows at 0.75% at last month's meeting. The main potential for surprise, however, came from the possibility that the central bank would announce the implementation of negative interest rates (the rate paid to commercial banks when holding money). Since this would have been a bearish outcome for the EUR/USD, markets have since bought the Euro, pushing the CurrencyShares Euro Trust ETF (FXE) higher.

Long-Term Divergences Seen at the Fed

But the main question is whether or not these moves are sustainable. The Yen has seen gains of nearly 4% this month and the Euro has hit highs near 1.33 during the same period. Arguments for why the market reaction in the Euro can be described as "knee-jerk" and potentially unsustainable can be seen in the fact that ECB chief Mario Draghi said that while there is no immediate need to implement negative rates, the central bank is prepared to do so if the situation warrants. This stance at the ECB should be viewed in the wider global context, where the BoJ maintains it aims to double monthly purchases of bond assets to more than 7 trillion Yen.

This presents a wide divergence between what is seen in the announced policy aims of the BoJ, ECB, and the US Federal Reserve. The Fed's plans to slowly remove stimulus from the economy have gradually made their way into the financial headlines and this creates a scenario, which should continue to support the US Dollar on any dips going forward. This makes the latest activity in the Dollar-pairs highly attractive for those looking to re-enter the long-term uptrend in the currency. At these levels, traders should look to buy the US Dollar, as the latest central bank-fueled dip will prove short-lived.

Price Perspective

Arguments for Dollar strength are supported by price activity, as well. But more importantly, this bias is supported by activity in not only the Euro and Yen, but in the Swiss Franc and Australian Dollar also. These factors remain supportive for the PowerShares DB US Dollar Index Bullish.

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In the EUR/USD, prices have seen strong rallies, but will come into some difficulty at the 61.8% Fib retracement of the decline from this year's peak at 1.3710. So while there is some scope for small moves through here, the rally is becoming unsustainable, and the CurrencyShares Euro Trust ETFshould be sold.

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In the USD/JPY, prices are also dealing with the 61.8% Fib retracement (of the rally from 90.90. We have seen prices move below this level but without a daily close below here, look to sell the CurrencyShares Japanese Yen Trust.

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Further evidence the US Dollar is ready for reversal can be seen in the Swiss Franc, with the USD/CHF now heading into historical demand levels at 0.92. This leads us to an overbought bearish bias in the CurrencyShares Swiss Franc Trust (FXF).

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Finally, the Australian Dollar has moved to new lows for the year, and prices in the AUD/USD will be forced to contend with another 61.8% Fib retracement (of the move from 0.8060 seen in 2010). This suggests the declines are in need of a corrective bound and equates to a bearish bias in the CurrencyShares Australian Dollar Trust (FXA).

About the author:

Richard Cox
Richard Cox is a university teacher in international trade and finance. Lecture halls of 80 to 120 students. Lessons in macroeconomics and price behavior in equity markets. Investing strategies in these articles are based on technical and fundamental analysis of all the major asset classes (stocks, commodities, currencies).

Trade ideas are generally based on time horizons of one to six months.

Follow me on Twitter: @Richard_A_Cox

Visit Richard Cox's Website


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