Chapter 2  Environment of Currency game

The 10-year rate and the dollar were both down on the week; the rebound I expected just didn’t happen (yet). That does not appear to be due to US economic weakness as the data for the week was actually pretty good. It more likely represents relative change as Europe’s outlook continues to improve somewhat. German PPI was down 4.2% in October as natural gas prices dropped while GDP for Q3 was positive (0.4% quarterly, 1.3% YOY) and the IFO Business Survey’s Climate and Expectations continued their improvement in November.

For all that Europe has suffered this year, it is probably surprising to the entire world that Germany hasn’t reported a negative quarter-to-quarter GDP change since Q1 2021. Maybe it isn’t so surprising that European stocks are outperforming US stocks this year and over the last 12 months.

The dollar, as I said last week, is now in a short-term downtrend. At around 106, the buck has support at 103 and appears to be headed for the intermediate-term uptrend line at around 102. To break the long-term uptrend that dates back to 2011 would ultimately require a drop to less than 92/93, a move that would likely take quite a while. We are really more interested in the intermediate-term trend so a drop under that 102 area would get us very interested in ramping up weak dollar investments. We’re not there yet but the move down has been pretty rapid so far. It should be noted too that the dollar could still rally to 110 or even a little higher and still be in a short-term downtrend. I suspect the immediate future is going to be very choppy.

Environment of Currency game -Pic no.1

Large speculators continue to trim their long dollar positions by the way. Most of the flow seems to be going to the Euro but the A$ and C$ are also seeing reductions in shorts. Maybe the most surprising currencies this year – although they aren’t really impacting the DXY – are the Mexican Peso and the Brazilian Real, both up on the year against the mighty dollar. Latin America is looking more and more interesting.

The 10-year Treasury yield closed the week down about 13 basis points (3.69%) with support still a bit lower around 3.5%. I continue to believe though that this move down in rates is not signaling recession (yet) and that rates are likely to rebound, if not to new highs. The key indicator here is the 2-year note yield which has fallen much less than the 10-year. If the market perceives that recession is imminent, it won’t matter what the fed wants to do, the 2-year yield will drop rapidly and steepen the yield curve. We aren’t there yet.

I do think short rates are peaking as shorts continue to cover in the Eurodollar market. The Eurodollar curve is pointing to a peak in rates around 5.25% in late spring/early summer next year which would likely put any recession somewhere beyond that. But, as I’ve said many times, that is subject to rapid change; it is just a snapshot. Personally, I don’t think rates will get that high but we’ll get a bumper crop of economic data next week that may clear things up.

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