There Just Isn’t A Clear Sign Which Way The US Dollar Is Headed Right Now by Eric Bush, CFA – Gavekal Capital Blog
We usually like to blog about trends that seem pretty clear when one dives into the data. However, a big issue in the market that we are grappling with right now doesn’t seem to have a clear trend. That issue is the US dollar. The US dollar’s rise since 2011, but especially in 2014, brought the reserve currency of the world to the forefront of most investors minds. A rising dollar is usually bad news for EM stocks, US corporate profits, and commodity prices. Therefore, if the dollar’s bull run has ended there are major ramifications for securities around the world. And while we wish we could give a firm answer to which way the dollar is heading, a trend one way or another just hasn’t clearly presented itself yet in our opinion. So perhaps that means the dollar will continue to be stuck in the trading range it has been in since early 2015? The evidence from a couple of our currency diffusion indexes suggest that this may be the case.
In the first chart below, we show a diffusion index using 12 developed world currencies. If a currency has been stronger against the dollar over the past year than it registers a “1”, if it has been weaker it registers “-1”. Over the past two months, our developed world currency diffusion index has moved from a max strong USD level of 12 to a slightly weak USD level of -2. This is first time since August 2014 that the currency diffusion index has moved negative. So over the past 12 months, the dollar has strengthened against 5 currencies and has weakened against 7 currencies. This explains the trading range the nominal trade-weighted dollar index has been in during the past year.
On a purchasing power parity basis, the dollar has also recently moved from basically its most bullish level since 2009 to a slightly bearish level. However, again it is not clear of this is the beginning of a new weakening dollar trend or just a breather from the a fairly relentless bull market form 2014-mid 2015.
Together, these two diffusion indexes clearly show that the dollar has been weakening since the middle of last year. However, unfortunately for now it seems that only time will tell if the dollar is simply consolidating before another move higher or if a true trend change has taken place and the world is about to again enter a phase of a weaker reserve currency.