Citi Warns “Unwise To Short The Dollar”

Citi sees a number of parallels, both in terms of the background dynamics and the course of events, seen throughout the 1990s and more recently over the past 7 years. As Tom Fitzpatrick notes, these similarities are not confined to the US economy but incorporate developments on a global scale and stringly support their view that the US dollar should rally for about another two years.

Via Citi FX Technicals,

Similarities in the course of events and the trends in the USD

– 1989-1991: The US housing boom ended with the savings and loans crisis which in turn led to a severe recession. The Fed cut rates and the USD continued lower

– 2005-2007: US housing boom came to an end as over lending could no longer be sustained, especially Sub-prime lending. The USD continued lower and the Fed started its rate cutting cycle in September 2007.

– 1992: UK housing boom also came to an end – the housing and credit cycles in the UK are quite in line with those in the US. The UK was fixed into the Exchange Rate Mechanism at an unsustainable rate and in the end left the ERM. GBPUSD peaked from just above 2.00 and fell to the low 1.40’s in a matter of weeks

– 2008: The UK housing bubble came to an end. Over lending in nearly all parts of the economy, public and private sectors, came to an end and GBPUSD collapsed from a little over 2.00 and fell to 1.35. The downtrend was further exaggerated as the USD rallied across the board during the major financial markets meltdown post Lehman Brothers.

EUROPE

– 1995: All currencies locked into exchange rate bands left the system and it imploded. All European currencies devalued against the German Mark but the USD started to outperform. It was a major platform for a 5 year USD bull market

– 1998: The convergence trade in EU peripheral bonds (and currencies as they converged to the EUR entry rates). During this period into October of 1998 European currencies did better rallying 16.5% against the USD from August 1997-October 1998. As convergence “ran its course” the EURUSD rate fell for 2 years into 2000.

– 2011: No currency in Europe could devalue against each other because of the “fixed exchange rate” system called the single currency. Europe went through a Sovereign bond markets crisis. The EUR posted a significant high against the USD

– 2014: We have witnessed the peripheral Bond markets convergence trade in Europe since the summer of 2012. At this point Spanish and Italian 10 year yields are only about 60 basis points above the US. If, as we expect, long-term yields are set to rise in the US this does not seem to be a sufficient premium to take that risk.

JAPAN

– 1995: USDJPY was already trending down but the Kobe Earthquake led to significant JPY repatriation. USDJPY fell to the trend lows at 79.75.

– 1997: Japan raises its consumption tax

– 2011: USDJPY was already in a downtrend as carry trades seen years before had ended and interest rate differentials had moved in favour of the JPY. The Tsunami and subsequent Fukushima disaster send USDJPY to new all-time lows.

– 2014: Consumption tax rise coming in April

LOCAL MARKETS

– 1997-1998: The exchange rate regimes in Asia came to an end with a number of countries defaulting. Russia also defaulted in 1998. While there was volatility in G10 markets as the USD actually went down instead of up because the market was too heavily positioned long the German Mark (As a hedge to the concern that German banks were heavily exposed to Russia), the correction down in the USD was short lived and a platform was set for another 2+ year rally into 2000.

– 2013-2014: A number of Local Markets came and are still under pressure as assets are sold and foreign flows are reversed. This has largely been a direct consequence of changes in Fed policy (tapering) and the economic situation in some of those markets. Further outflows are likely over the course of the months ahead as the Fed finally heads towards a more normalization of monetary policy.

USD Index – back above the previous low

The USD Index posted a decent up week last week and a weekly close above the December 2013 low of 79.68

Weekly momentum is also beginning to cross back up again

Decent resistance levels come in at 81.38-81.45 which are likely to be tested over the coming weeks. A weekly close above those levels would amount to important breaks if/when seen

The setup may be seen as a double bottom pattern with a neckline at 81.48. A weekly close above there would open the way for 83.68 at a minimum.