Dollar Losses Accelerate, Adjustment Not Over

The US dollar had one of its worst weeks of the year, as its interest rate support eroded. Despite prospects for a further upward revision in Q2 US GDP above 3.0% and continued above trend growth, the market continues to downgrade the chances of another rate hike this year. The CME’s model suggests the odds of a hike by the end of the year fell to about 26% from 42% a week ago.  

The early retirement of the Federal Reserve’s Vice Chairman Fischer and reports that suggest the chances of Cohn replacing Yellen have fallen may have contributed to the reduced expectations and the weaker dollar.  Cohn represents a key part of Trump’s coalition, and if he does not get the appointment, or is otherwise sidelined, the energy behind the economic program is diminished.  That, in turn, means that the current economic challenges, like the reduced growth potential and weak productivity, aren’t likely to be addressed. The implication of this is that the US 10-year yield can return to levels seen before last November’s election. At the end of October 2016, the US 10-year yield was 1.85%, approximately the level of trend growth.   

The Dollar Index has now met the 50% retracement objective (~91.20) of the rally that began in mid-2014.  The 1.6% decline last week was the largest in Q3. The technical indicators suggest this leg down has more room to run. The 61.8% retracement is found at 88.25. On the upside, a move above 92.20 would help stabilize the tone. One note of caution comes from the magnitude of the fall that has pushed the Dollar Index below its lower Bollinger Band (~91.50).  

The ECB’s concern about the euro’s appreciation has risen since July meeting, but it still has not reached the official pain threshold. The market’s enthusiasm for the euro has not waned.The 50% retracement of its decline that began in mid-2014 and through a low set at the start of the year is found near $1.2165. Beyond there, it potentially extends toward $1.25-$1.26. The technical indicators are constructive, and buying on dips is still the preferred strategy for trend followers and momentum traders. We expect new buying to emerge on pull backs into the $1.1960-$1.1980 area.