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Fading The Greenback

10/15/03 04:31:09 PM PST
by David Penn

International currencies suggest that the dollar may be down, but it isn't quite out yet.

If there is a consensus on any market in the world, then that consensus is bearish and that market is the US dollar. It is virtually impossible to find a responsible economist or financial analyst who believes that the US dollar which fell to 1998 levels in the last week of September 2003 in the wake of news that Japan would stop intervening in the currency markets to artificially depress the yen has any business moving up. The arguments in favor of a lower dollar are colossal: record levels of government spending, a Federal Reserve that promises to keep monetary policy "accommodative," a dollar price for gold flirting with $400 and the charts of price action in the US Dollar Index are all the more convincing for those stubborn few who believe that, at a minimum, a bounce in the greenback is more likely than not.

Figure 1: A major test of support at the 92 level looms for the US Dollar Index.

In fact, except for a few lonely voices, not only is there a near-unanimous view that the US dollar will fall, but also there is quite a population of observers that actually believes that a falling dollar is an unqualified good. Stephen Roach, Morgan Stanley's chief economist, began a recent dispatch titled "Breakthrough" with a note of particular triumph. Writing about the September 2003 Group of 7 meetings in Dubai, Roach proclaimed that:

The world's major industrial economies have endorsed the basic premise of global rebalancing a long overdue adjustment in the dollar. This could well have profound and lasting implications for the world's economy. It is an unequivocally positive development, in my view.

Many of these observers qualify their longing for a lower dollar with a stated preference for an "orderly descent." But the fact of the matter in the markets is that once "descent" has been clarified as the objective, the means of obtaining that objective will be determined in the marketplace and "orderly" may or may not be the way the marketplace decides to move. As Roach recalls, the last "full-blown current account adjustment" in the late 1980s resulted in a 30% depreciation of the dollar. It is worth remembering that the "Black Monday" crash of 1987, the mini-crash of 1989, and the recessionary early 1990s all followed shortly afterward.

But those who have been banking on a lower dollar should realize there is a difference between an accurate forecast and what traders like Bruce Gould refer to as "trading the line." Often, fundamental market conditions (or political ideology) can suggest what the likely outcome is of a given market event. But how will that event come about? Will it arrive directly, will it arrive through some tortured, convoluted process, or will it arrive in some fashion in between? As Gould noted back in 1976:

There are two major problems in your search for large commodity trading profits. First, you have to accurately forecast commodity prices, and second, you have to trade the line. Most traders think that forecasting is all there is to commodity trading, but in fact forecasting is the minor part of the business. It is trading the line which is difficult.

I've frequently presented the case for a higher dollar at a minimum as a temporary technical bounce before in But I think the case for a near-term move up in the dollar in spite of its recent dive toward critical technical support might be made more compelling not by focusing on the dollar, but by looking at some of the major currencies against which the dollar competes.

Some of the price action in currencies such as the Swiss franc, the euro, and the British pound as well as the "resource currencies" seems especially indicative of market tops. If this is true, the case for a higher dollar on the intermediate term might be underscored. When the extent of the bull markets in currencies such as the Swiss franc and the euro are examined, for example, the case for the overvaluation of these currencies (the economies of which are still largely defined by the amount of goods and services they can sell to Americans) becomes as strong as is the case for a temporarily undervalued US dollar.


Commodity price movement is among the chief reasons for dollar bullishness (though, again, any dollar bullishness would appropriately be seen in the context of a bear market rally not unlike the brief, sideways greenback bear market from mid-1997 to the end of 1998). By "commodity price movement," I'm referring particularly to gold and crude oil that have their own exclusive, more or less inverse relationships to the greenback.

Much of this discussion about commodity relationships with the dollar was included in a previous "Market Update" ("Kings of Commodities," August 13, 2003). So instead of rehashing those arguments, I'll shift to the recent (and not-so-recent) price action in the "commodity currencies" such as the Australian and Canadian dollars.

Figure 2: After a two-year bull market, the aussie struggles to maintain higher ground. Note the negative divergence between price action and the oscillator.

The bull market in the Australian dollar has seen this commodity currency gain more than 54% since its lows in the spring of 2001. Even over a two and a half year span, this is an incredible rate of appreciation for a major currency. Most recently valued above 0.6800, the aussie is at a higher level than it has been since the autumn of 1997. The Australian dollar in the late summer experienced a mild correction down to as low as 0.6280 before rallying to set a higher high vis-à-vis the previous high in July.

Although there has been some upside volatility in the way of a gap up in the December futures, there is also a clear negative divergence developing between aussie price action and the 3/10 oscillator. The December aussie has, as of early October, taken out the previous contract high set in early July even as the forementioned negative divergence grows. If these futures fail to follow through significantly to the upside, then the case for a reversal in the aussie and, by extension, a move up in the US dollar would be strengthened.

The Canadian dollar has not seen quite the appreciation as the Australian dollar has. But its bull market since the spring of 2002 when the loonie was priced at about 0.6023 has been impressive. As of late September 2003, the Canadian dollar was up some 23% from its 2002 lows. Like the aussie, the loonie has also experienced a correction off its early summer 2003 highs and is in the process of trying to reestablish a higher high. As "resource" currencies, it is probably worthwhile to watch both the Australian and Canadian currencies at the same time. Any initial sign of weakness in one quite likely will anticipate similar weakness in the other.

In the same way that corrections in commodities like gold and oil tend to signify a rising dollar, so do corrections in commodity currencies tend to hint toward higher greenback prices. In some respects, commodity currencies are doubly affected; as competing currencies, they tend to move contrary to the US dollar, and as commodity currencies, their movements are heavily influenced by commodity prices, which also tend to move contrary to the US dollar.


European currencies are in a similar position to the resource currencies. All of these currencies European and the commodity currencies of Australia and Canada peaked early in the summer of 2003, and corrected in the autumn. As September unfolded, the euro, Swiss franc, and the British pound all rallied sharply in advances characterized by gaps and nearly vertical movement to the upside. If it is true that it is dangerous to sell the first significant decline after a major peak, then it is also probably true that it is dangerous to buy into the first major rally following that initial correction.

Elliott wave practitioners tend to think of this situation as the problem of A and B waves in corrections. Robert Fischer, in his Fibonacci Applications And Strategies For Traders, goes so far as to suggest that A and B waves are virtually untradable. This is insofar as the extent of both the initial decline from the highs ("A") and the initial "snapback" rally ("B") cannot be accurately forecast.

A survey, for example, of the different types of corrective patterns in Elliott wave methodology underscores this. From what are referred to as "expanded flats" in which the snapback rally ("B") peaks higher than the start of the initial correction (that is, the peak of the previous advance), to regular flats in which the B rally falls short of the prior peak, these two initial movements coming off a peak are difficult to gauge. In the context of the bullish advances in global currencies that has taken place in late September and into October, just because prices take out their summer highs does not necessarily mean that the two- to three-year bull market has resumed. If bull markets in these currencies do reassert themselves, there will likely be plenty of time and room for those interested in getting in on the long side.

Looking at the three main European currencies the euro, the British pound, and the Swiss franc there are precious few differences between them and the resource currencies of the aussie and the loonie in terms of straightforward price action. The current challenge to the bull markets in these currencies remains the summer highs.

As of this writing, this is one difference between the European currencies and the resource currencies whereas the resource currencies have both taken out their summer highs, the European currencies have so far failed to do so. Nevertheless, the same negative divergences between price action and the oscillators that characterize the September/October rallies in the resource currencies at present are evident to a degree in the European currencies and point to the same upside risks of reversal.


If there is one currency whose appreciation against the US dollar is likely to continue, then that currency isn't in Europe or in the resource-rich nations of Canada or Australia it's in Japan. As I have suggested since the beginning of 2003 (and most recently in a Advantage piece, "Now And Yen," September 23, 2003), the yen has developed a massive head and shoulders pattern that has been more than two and a half years in the making. While there is reason for the greenback to appreciate even temporarily against most global currencies, recent price action in the yen suggests that the Japanese currency's long undervaluation relative to the greenback is over.

Whether this bullishness with regard to the yen is a function of economic growth in Asia compared to the rest of the world, the decision of the Japanese monetary authorities to end their campaign to suppress the yen, or something else altogether, both technical and fundamental factors are currently conspiring to drive the yen higher relative to the dollar (and relative to the euro and the British pound as well, for that matter).

Figure 3: This head and shoulders formation suggests a large move in the yen versus the greenback.

If there is something to the notion of bearish euphoria, then that notion applies nowhere as well as it does to those betting against the US dollar. Again, that bearishness is not without reason. The price chart of the US Dollar Index shows a steep decline over the past few years, the European Central Bank has acknowledged that a higher euro is consistent with concerns over growing US trade and budget deficits, and there is growing evidence that the loci of global economic growth going forward will be in Asia, not the United States.

But every bear market is occasioned by intermittent bear market rallies often quite powerful ones, at that rallies that gain a significant measure of strength from the very entities betting against them (read: short squeeze). And while greenback bears grow as complacent and overconfident as Nasdaq bulls in 1999 (or Nasdaq bears in late 2002), the possibility of a reversal becomes more likely.

After a certain point, the notion of a falling dollar helping US manufacturers is a poor palliative for a world's de facto reserve currency that is on the verge of collapse and the temptation to intervene on behalf of the dollar (through higher interest rates or gold sales or some other mechanism) becomes overwhelming. The history of markets is such that when this moment comes, it is always too soon for those who believed it would never happen at all.

David Penn may be reached at

Suggested reading

Agence France-Presse (AFP) [2003]. "ECB's Duisenberg says readjustment of dollar inevitable," October 6.

Fischer, Robert [1993]. Fibonacci Applications And Strategies for Traders, John Wiley & Sons.

Frost, A.J., and Robert R. Prechter Jr. [1978]. Elliott Wave Principle, New Classics Library.

Gould, Bruce [1976]. Commodity Trading Manual, Bruce Gould Publications.

Penn, David [2003]. "Kings Of Commodities,", August 13.

Roach, Stephen [2003]. "Breakthrough," Global Economic ForumWeekly Commentary, Morgan Stanley, September 22.

Saville, Steve [2003]. "Central Banks, Currencies and Interest Rates,"

Wallenwein, Alex [2003]. "Is the dollar 'Toast?'" The Euro vs. Dollar Currency War Monitor.


Current and past articles from Working Money, The Investors' Magazine, can be found at

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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