Currency Corner: what’s next for the US dollar?

US dollar bills © Chris Ratcliffe/Bloomberg via Getty Images

“What shall I write about in the week’s Currency Corner?” is a question I usually ask myself at the beginning of each week.

Sometimes the answer is obvious, and this was one of those weeks. It has to be the US dollar.

It is breaking out to new highs. And on America’s Labor Day holiday as well. That’s significant. It’s when the US fully gets its head back down to work after the summer hols.

The implications to the rest of the world’s markets of a US dollar index breaking out to highs not seen since the spring of 2017 (just a few months after President Trump took power) are enormous. It tells you where the world’s capital is flowing.

On Tuesday, we got those new highs. Then it’s as though the world’s currency traders, as one, suddenly sat up at their desks and thought: “Well, actually… I’m not so sure about this.”

And the market reversed. Quite significantly so. What gives?

A brief history of the dollar since Trump was elected

Let’s start with a three-year chart, showing the US dollar index – that is, the dollar versus the currencies of the US’s major trading partners (the pound, the euro, the yen, and so on).

US dollar chart

I’ve marked the point at which Trump was inaugurated in January 2017. You can see how the US dollar went into a bear market. All his spending plans meant money printing. The world did not feel all that comfortable about its reserve currency with such a maverick in the White House.

And, according to my trend-following system, we got a sell signal, which I’ve also marked.

However, since the spring of last year, we have had quite a bull market. There was a definite low around the turn of 2018 – re-tested several times – and since then the trend has been up. I’ve marked the buy signal.

In June this year, we got a sell signal, which quickly reversed back to a buy (not marked in the chart), and the dollar has been rallying all summer.

Markets are not sure of where they want to go

And so that brings us to this week.

Here’s a chart which shows the last three months. You can see the trend is clearly up. That trend line is still comfortably intact. But still the last three days have seen quite something of a reversal.

US dollar chart

It came on Tuesday. The dollar broke above its July highs to two-year highs. But then it reversed.

I’m a big fan of the phrase – “from false moves, come fast moves – in the opposite direction”. Was that break to new highs a false move?

For now the trend is still intact, so we have to give it the benefit of the doubt. We got a similar decline at the end of August. Perhaps this one will level out too.

But this is definitely one of those moments that makes you sit up and take note. Something is going on.

Yesterday we got news that China and the US chief trade negotiators have agreed to create favourable conditions for trade talks in October. I’m not sure quite what that means (and I’m not sure anyone else is either), but it led to a big rally in US stocks, a fall in the gold price and a moderate intraday recovery in the dollar.

A lot of dollar traders look to the gold market for direction. And of late we have seen the unusual situation in which both gold and the US dollar have been rising together. Yesterday we got a $45 sell-off in gold. It’s clawed back a bit since.

The US stock indices meanwhile staged quite a rally – over 400 points on the Dow Jones.

We seem to be at one of those junctures in which nothing can quite decide where it wants to go and the result is whipsawing action – reflective of the US-China trade talks. It will settle after a while, and trends will re-form. The question is: in which direction?

Make sure your risk is managed.