The US Dollar Index: The Bear Market Rally is over!
The U.S. Dollar Index ® is computed using a trade-weighted geometric average of six currencies.
The six currencies and their trade weights are:
| Currency | Currency Weight % |
Euro
Japan/yen
UK/pound
Canada/dollar
Sweden/krona | 57.6
13.6
11.9
9.1
4.2 |
The long-term picture
The triple top through which the Index worked its way between September 2000 and the beginning of 2002 clearly suggested a tremendous change of fortune for the US Dollar, which led to the conclusion that the following down-trend was likely to be a bear market of significant proportions.
Nevertheless, trends do not evolve in a straight line but are interrupted by various short-term counter-trends.
As the above chart clearly demonstrates, we experienced different counter-trends on the way up,
ranging from 7 to 9% from high to low. On the way down, the same phenomenon occurred and, incidentally, the magnitude shows some constancy.
The last reaction in the down-trend, for example, took the US Dollar Index from a low of 91.88 to a high of 99.49 points. This represents 8.28% and is well within the limits of previous corrections in the up-trend as well as in the down-trend.
We also notice that the trend-change from up to down took more than a year, which shows that the market participants do not normally change their long-term views overnight.
To conclude, we continue to believe that we remain in the down-trend, that we have gone through a normal correction and that this correction has run its course at the peak of 99.49 points.
We are most likely in the turn-around phase of the correction process and should we break below the previous low of 91.88, we would conclude that the major down-trend is indeed alive and intact.
Nevertheless, should the US Dollar Index unexpectedly strengthen and close above 100 points, we may reconsider what has been outlined above.
The medium-term picture
The counter-trend in the bear-market has been stronger than we suspected, even though we have to admit that it is still not excessive, judged simply by the size of the reaction at from the low of 8.25%.
Any market reacts to short-term considerations based on technical analyses, hope and fear. Forced covering of long- and short-positions because of insufficient margin is also an important factor and it is well known that positions must often be liquidated, when in fact they should have been maintained. Fear is an emotion difficult to control, and is indeed beyond the scope of many people.
The medium-term chart shows that we had two correction highs around 97.50 points right at the trend-line and the conclusion was, of course, that from here the down-trend would be resumed. However, this was not the case. When the Index closed higher than the above-mentioned marks, the market had the strength to add 2% to this movement.
As often happens in such circumstances, once buying power dries up, the reversal of the short-term trend is swift and brutal and leaves many bruised soles and empty tills behind.
Apart from daily fluctuations, we assume that the medium-term trend will lead us in due course to test the previously established low of 91.88. This could well happen within a few days but could also take several weeks.
The fortune of the US dollar depends on foreign buying and, at present, it seems that few foreign central banks and investors see many alternatives to this reserve currency. More on this below.
The short-term picture
Short-term, it is evident that the up-trend has been broken. A double-top was formed from which the Index broke away and dropped below the up-trend line.
After minor consolidation, the down-trend was resumed. We would be surprised if this down-trend
reversed quickly.
The phenomenon of foreign US dollar buying
During the first half of this year, foreigners bought American securities for the value of USD 387.7 billion, 40% more than during the same period of the previous year. 95% of this money was used to buy fixed interest securities. Foreign investors, in fact, financed 26% of the new net-debts incurred by the USA, so that some commentators argue that foreigners financed the war in Iraq while not fighting it on the ground.
During the period April-June, foreigners bought US-Government papers worth USD 154.4 billion, which represents 80% of the new net-debts run up by government agencies.
Among foreign buyers, Japan alone contributed USD 76.5 billion.
As long as massive foreign investments flow to the USD, the retreat of the value of the US dollar may follow an orderly path. But how long can this last in view of the worsening trade and budget deficits?
The US Dollar Index has fallen 24 % from its high reached in July 2001. Think of all the foreign central banks (Russia, China, Japan, Taiwan etc.) holding huge amounts of US dollars as their reserve currency - a reserve which is continuously losing value against their own currency.
Would it not be a logical step, alleviating fear, to diversify out of dollars?
The following recommendations were valid at the time of writing, viz. at
and may no longer be relevant at the time of reading.
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Peter Zihlmann
September 17, 2003
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