Here’s the setup for dollar decline in September
In the last update
we made about the dollar on June 10 we said
that our expected strong rally from January to June would be followed by a
renewed slide from September to December. Below is the same chart from our May 8
report, which we updated on June 10 to publicly say, "We will soon look to close
out our dollar longs" from earlier this year.
We forecasted a top at 91 and the actual price
high was 90.77. So with our dollar forecast right on track, we have warned for
the past month of the upcoming “September Slide†which would see the dollar
decline from September to October.
The reasons are quite simple – The fundamental
driver of currency rates (as we explained many times) is interest rates.
Longtime readers should remember that our forecast was for a rising US dollar
from January to August 2005 then a decline from September to December. We said a
top in the dollar would coincide with a peak in the Fed’s rate hiking cycle at
3.5%.
While the rest of the market was calling for 4.0% a month ago, we note that
the recent decline in the 5-year and 10-year notes to 3.77% and 3.98% makes
another Fed hike too close for comfort. The Fed now risks inverting the yield
curve with another rate hike. This situation is causing traders to unwind long
dollar positions in droves.
Below we show the yield ratio between the 5-year note and the 3-month Treasury
bill. Recall that the last two times this ratio threatened to invert the Swiss
franc/US dollar rate saw a sharp spike (orange). This is simply Economics 101 at
work.
The difference this time though is that the US dollar will likely undergo a 3-4
month correction of its recent gains but will rally again in 2006 because of the
large interest rate differential in its favor. Recall that we predicted a dollar
rally from January to August to then reverse course in September as the market
realized the Fed would pause in its interest rate cycle at 3.5%. This in turn
would cause an unwinding of long dollar positions, which would set up the next
significant rally for January to August of 2006.
Jes Black
Jes
Black is the fund manager at Black Flag Capital Partners and Chairman of
the firm’s Investment Committee, which oversees research, investment and
trading strategies. You can find out more about Jes at
BlackFlagForex.com.
Prior
to organizing the hedge fund he was hired by MG Financial Group to help
run their flagship news and analysis department,
Forexnews.com. After four
years as a senior currency strategist he went on to found
FxMoneyTrends.com – a research firm catering to professional traders.
Jes
Black’s opinions are often featured in the Wall Street Journal, Barrons,
Financial Times and Reuters. He has also written numerous strategy pieces
for Futures magazine and regularly attends industry conferences to speak
about the currency markets.