I Am a Dollar Bull with Conviction

I have been a US Dollar bull (DXY) since October of last year. Since then, the dollar index has declined roughly 3%, however, I remain quite bullish on the currency.

First of all, let’s clarify a couple of things.  Here’s a good article describing what the DXY actually is. It is a geometrically-weighted index of some of the US’s major trading partners. Taking a glance at the picture above, you can see it is predominantly weighted toward the Euro, followed by the Japanese Yen, the British Pound, Canadian Dollar, Sweden Kroner, and Swiss Franc.  The index could be described as an anti-Euro index.  Many would argue that the index is outdated and does not reflect the value of the dollar against a broad basket of currencies and I actually agree. The dollar index should be updated to reflect the growing importance of the Asian region with regards to global trade.   For the time being though, I have been using this index to track the currency and my bullish stance has been based on it.  Given its current weighting, you could derive that a bullish call on the DXY would constitute a geometrically weighted bearish call on the Euro, Japanese Yen, UK Pound, Canadian Dollar, Sweden Kroner, and Swiss Franc.  I’m ok with that.  Now that we have more clarification on what being a Dollar bull exactly entails (at least in my context), I can move on with why I believe the US dollar is undervalued.

The first reason boils down to sentiment. Dollar bearishness is extremely high and the “sell-the-dollar” trade is very crowded. A lot of bad news is priced into the currency as fears of hyperinflation and a dollar crisis are widely discussed. I believe these fears are misplaced as does the Treasury market. At this point, simply not having bad news could cause a bullish reaction in the US dollar as there is no one  left to sell the currency.

My second reason involves politics and a general view of Bernanke’s strategy. More people, ranging from analysts to journalists to even officials within the Fed are beginning to question whether quantitative easing is doing more harm than good for the US or global economy.  Some are even blaming Bernanke’s quantitative easing experiment on the Arab uprisings! This news is being disseminated to the public. Bernanke is coming under increasing pressure from all sides it seems as to why quantitative easing has not worked as expected.  If the economy went back into recession, quantitative easing will have been deemed a failure and that means that it will be very difficult, if not impossible for Bernanke to restart the monetary spigot in the short-term. There would be a profound psychological shift against the Fed in my view.

My third reason for being a US Dollar bull stems from the many external risks around the world to the global recovery.  I covered these reasons a myriad of times so I won’t go into too much detail but for a quick refresher, here are links as to why I see trouble ahead for the Euro (see here, here, here, and here) and China (see here, here, here, here, and here).  The Middle East uprisings have added an extra layer of uncertainty to the picture. If any of these factors spirals out of control, the global recovery will be in grave danger of being upended. This would result in a large inflow into the US dollar as it is still considered a safe haven currency, like it or not.

My final reason for shading bullish on the dollar comes down to the US economy. Economic growth has disappointed as of late and tying in with my second reason, many are beginning to blame the Fed. It’s perfectly understandable, given the high correlation between the initiation of QE2 and the rise of commodity prices. Gas prices have become a large burden on the consumer as well as businesses. Economic growth is coming dangerously close to stalling.

Despite pervasive bearish sentiment, due to the aforementioned factors, I maintain my bullish stance on the US dollar (DXY). Main Street is still saving and paying off debt (the structural foundations of the recovery are suspect). External risks abound, which could derail the global recovery. If things begin to go awry, the Dollar will still be the safe haven currency.

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