Why The Fall of the US Dollar is Going to Have a Domino Effect That Will Present Some of the Biggest Opportunities of the Decade
The Japanese yen (JPY) has been making some very interesting moves against other currencies recently. I’ll cover that scenario in detail later in this report, but first a few words on the world’s reserve currency: the US dollar.
That’s because if you've been my weekly reports for the last several weeks, you'll know that I’ve been very bearish on the US dollar. I practically called the top of the dollar during the height of the coronavirus panic in March.
That was when everyone rushed into US dollars because of fear. Everybody in the world was selling their assets to buy dollars.
But before I look at the US dollar chart, I want to give you a background idea of what’s happening and why. Now I'm not a fundamental trader, of course. I don't really care about the “reasons why”, but there’s a lot going on right now and so it’s useful to point out a few things.
What exactly is driving the US dollar lower right now?
In the bar graph below, we can see that US interest rates are now showing negative real yields. Even though they’re showing a positive yield “nominally”, when you subtract the inflation rate the “real return” is actually negative.
In fact, all the world’s central bankers are in this race to the bottom for interest rates. We're heading into negative interest rates and frankly into uncharted territory together.
Certainly in the US, we've never experienced negative interest rates and this is a key reason for the fall in the US dollar.
For example, right now the five-year Treasury Note yields 0.264%. But when you subtract US inflation you're left with a negative rate of return as shown here. The same is true for the seven year, the 10-year, the 20-year, and even the 30-year Treasury yields.
Now clearly a negative return is undesirable.
So investors will sell the US dollar for other assets and this fall in the US interest rates and the dollar has coincided perfectly with the rise in gold:
Right about the time rates started going negative, gold took off from $1,500 to just over $2,000 right now. The correlation between the two events is very strong.
All this is a function of the US Federal Reserve adopting the “whatever it takes” posture. During the height of the epidemic, they knew they had to act and act quickly. And cumulatively the US Federal Reserve and Congress together have issued about $10 trillion of stimulus in the last few months.
But they’re not done yet. Currently, Congress is mulling over another $1-3 trillion in the additional stimulus. All this has put huge pressure on nominal interest rates in the United States and there have been soaring asset prices in response.
This is setting up a condition of stagflation where you have depressed economic conditions along with rising inflation. This is a terrible outcome for savers and investors who aren’t aware of what's going on.
Fortunately, you’re aware now, which is why I’ve pointed this out. Stagflation is a real danger in times to come.
Now having said all that, let’s take a look at the USDI (the US Dollar Index), which tracks the US dollar against a handful of the most liquid currencies.
The rush into the US dollar at the height of the pandemic correlated to a breakthrough above a major resistance area and yet this rally has turned into a bull trap where anybody chasing this market was trapped.
It’s important to note when these happen because once traps are sprung, the market tends to move the other way in a hurry (i.e. down, in this case). Which is of course what we’ve seen over the last few weeks.
So where does the US dollar go from here?
It’s already come very far, very fast and further declines seem almost inevitable. However, the dollar has had a pretty good run and I'm also a bit skeptical of August trading conditions.
That’s because August is when most Europeans go on vacation and while they may continue to do so this year, numerous travel restrictions and general pandemic fear may mean they're not going anywhere this August. So I don't know if August 2020 will be typical.
Normally August is very much a consolidation month where prices go into narrow trading ranges and refuse to break out. Will that happen this year? For now, I’m taking a “wait and see” approach.
In the meantime, we can observe the bearish head and shoulders in USDI:
Head and shoulders are typically reversal patterns so I would expect USDI to drop lower over time.
However, price have broken through the neckline already. We often see a retracement and re-test of that neckline after that happens. Then the new downtrend begins in earnest.
So I wouldn’t be surprised to see a rally in USDI in the short term and therefore I wouldn’t be keen on shorting USDI at the moment. If you've got some gains from being short USD right now, I'd be inclined to take partial profits and look for another setup to consolidate your position going forward.
Meanwhile, EURUSD (the Euro versus the US dollar) has jumped from 1.06 all the way to 1.18 in the past few weeks:
For the past 10 years, EURUSD has been in a robust downtrend that took it all the way from 1.60 to about 1.02 in the depths of the bear market.
However, I believe EURUSD is turning around into an emerging bull market.
As traders, we're often presented with a conflict when presented with a number of opposing patterns. We’re left to decide which one is the governing price pattern.
EURUSD is a great example as we have not one but two bearish head and shoulder patterns, but now also an extended Eve and Adam bottom with the Adam bottom forming what looks like an inverse head and shoulders pattern with a sloping neckline -- all of which is bullish. (An Eve bottom is large and rounded with multiple common lows while an Adam bottom is very spiky in comparison. And a sloping neckline is one tilted from the horizontal in the direction the market wants to go.)
These opposing patterns suggest that what doesn't go down must go up.
In fact, the recent sloping neckline suggests that EURUSD is going to keep going higher, perhaps even explosively.
There are only two things which could hold it back in the near term: August is traditionally very quiet (as I mentioned already), plus EURUSD is also at a key resistance level after its recent run.
So despite being very bullish here, I would not be surprised to see some consolidation activity at or around current prices.
If so, any pullback in EURUSD should be bought on the expectation that this pair is likely headed much higher over the next few weeks, months and perhaps even years.
Now I want to discuss the Japanese yen correlated trading pairs.
In the last couple of weeks we've seen some trading action that has been counter to my expectations and given rise to certain trading decisions.
I'll start by looking at USDJPY (the US dollar versus the Japanese yen):
Going all back to 2015, the head and shoulders with a double top price pattern has been the governing pattern for this pair. I've discussed this in perhaps every report I’ve published for the last several months. My feelings were (and are) bearish on USDJPY due to an overwhelming number of bearish price signals.
However, after an attempted drop back down to the 104 – 105 common low of the descending triangle (which was consistent with my observation that we would challenge this area), USDJPY made a key reversal.
Ordinarily, I wouldn't put too much stock in a single weekly bar. But considering where the reversal occurred, I suggest you close out any USDJPY short positions for now. That means trades that I suggested a couple of weeks ago around the 106.50 area should be closed out.
I thought we would test perhaps the 100 – 101 area, but after the price action last week I'm going to cover my positions and take another look. I've learned that when we see key reversals at auspicious price levels, they give rise to rebounds.
When I look at this USDJPY chart I can’t see a sustained rally beginning, but I think its prudent to get out of the way of this one and take some profits off the table.
The descending triangle in this pair could also be considered a more neutral symmetrical triangle, by the way:
So I'm going to keep my eyes on how this price action plays out.
If USDJPY eventually rallies enough to emerge from the upside of this triangle, I’ll consider changing my long-term bearish mindset on this pair. It’s served me well so far because I've made a ton of dough shorting USDJPY.
On the other hand, there’s some interesting JPY behaviour in other pairs which suggest a weakening yen.
I’ll get to those in a moment, but first a quick note: if you followed my trades over the last couple of weeks, you'll know that I’ve been very successful lately. Especially in silver where I started buying silver in the low $18 area before selling at $25.87. I've also made a lot of money buying GBPUSD (the British pound versus the US dollar) and EURJPY (the Euro versus the Japanese yen) while shorting USDJPY as I’ve just discussed.
But I'm most proud of the GBPJPY (British pound versus Japanese yen) trade.
In an email I sent to Elite members about a week ago, my recommendation was to buy GBPJPY at 135.95 and already we’re up about 250 pips. This is a nice trade but certainly not the best trade I’ve had recently.
But I’m proud of this trade because I was fighting my natural instincts.
I was fighting a bias but eventually, I capitulated to what I was seeing on the charts. This is why I always emphasize that you have to be completely objective with your trading. Drown out the noise and the external stimulus of outside opinions, and also pay attention when your internal biases don’t match up with price action.
I’ve been bearish on GBPJPY but price action was signaling continued momentum to the upside. There was an intermediate double bottom and then (just prior to the email) a key reversal. I was clearly late to the GBPJPY bull party, but to my mind, if you can't beat them you have to join them.
Once I recognized that what I thought was a bear market was instead a market with higher lows. This is counter to what a bear market should be.
Let’s look at an updated chart of GBPJPY so you can see what happened since that email:
Some history first: for a long time I viewed GBPJPY based on the governing price pattern I detected back in 2015 starting with a double top that was soon revealed to be the head of a bearish head and shoulders.
Once the neckline was breached, GBPJPY dropped like a stone from 195 all the way to 120.
And since then, the pair has traced out what appears to be a long-term rounding top with multiple top patterns. This is consistent with the long-term downtrend.
When GBPJPY began its most recent rally, I assumed this was another counter-trend move like several before it. I assumed that despite the low made during the pandemic panic, GBPJPY would soon be on its way back down in confirmation of the main downtrend.
However, this pair kept making higher lows as it established and then continued hugging a fresh uptrend line. Then last week I got in at 135.87 and GBPJPY has burst upward since. I think it will keep going now because the price action isn’t consistent with counter-trend rallies.
Now it might turn around and revert to its initial bearish downtrend. But this feels different.
After all, we saw numerous markets (silver, the dollar index, and others) blow through to all-time highs or lows during the coronavirus hysteria, and those proved to be bull or bear traps. This price action in GBPJPY could be more of the same. Especially when the ‘coronavirus low’ matched a point of historical support from several years earlier.
Again, GBPJPY is looking like a case of ‘what doesn't go down must go up’. We might see a short squeeze once those who are short the market get pressured. When the market goes counter to prevailing expectations, GBPJPY could rise very quickly.
That’s why I remain long GBPJPY as the momentum looks to be to the upside in the near term.
Members of my Pattern Trader Accelerator program and Elite program also received a trade recommendation to go long EURJPY (the Euro against the yen) last week.
I'm pointing this out to illustrate why I like to get into the market with stop orders.
The nice thing about entering with a buy stop is that it requires the market to rise and confirm what you're looking at. On this chart, EURJPY was at resistance and I wanted to play any possible breakout.
For most of the ensuing week, EURJPY actually trended lower before finally moving where I expected. In fact, this trade wasn’t triggered until Thursday. So the buy stop went in the previous Sunday and then this trade didn’t trigger for four days following the entry order.
Why is that worth knowing? Because you don't have to look at your screen to get into winning trades like this. You don't have to look for some kind of magic crossover on a 15-minute chart or anything like that.
All you have to do is put in your buy stop at 124.37 and wait.
Let’s see why I made that call and why I’m cautiously expecting further gains in EURJPY:
Now as with USDJPY and GBPJPY, EURJPY has also trended lower, meaning that the yen was continuing to strengthen. I expected those trends to continue, but you can see that recent market action is counter to that assumption.
It's still reasonable to wonder if this is just a counter-trend rally in a down market, but my suspicion is that we're seeing something else.
In fact, EURJPY’s newest pattern – a bullish double bottom -- got confirmed by the thrust through the neckline just this week.
This is why I suggested putting the buy stop where I did. Even though it took most of the week to get there, EURJPY has now blown through the neckline of that double bottom and I've learned over the years to trust the most recent pattern.
There’s another way to view EURJPY too:
If you view EURJPY as trading within a symmetrical triangle, it’s now easier to see how it could rise to the upper trendline and beyond.
If EURJPY takes out the 127 – 128 area, that indicates much higher prices are likely to occur. So I’m now alert for a change in direction in these yen pairs, at least in the short term.
Now let’s review the recent price action in XAGUSD (spot silver):
A couple of weeks ago, silver broke out of its seven-year downtrend line and after forming a bullish inverted head and shoulders.
Silver has been propelled fundamentally by massive US stimulus and the crash of nominal Treasury yields as I explained earlier. So now that prices are higher, the only question is what they’re going to do in the near term.
Because silver has just exceeded a key resistance area, I wouldn’t be surprised to see it spend a bit of time at current levels. Especially considering August’s reputation for consolidation-type price action.
However, all the alarms and triggers have been set off in silver so perhaps it will rocket higher yet before we see genuine consolidation.
The only thing I know for sure is that silver is definitely headed higher no matter how long it pauses at current levels. Buy this on any weaknesses.
XAUUSD (spot gold) has also been very bullish lately.
Gold has been up, up, and away as it exceeded its all-time highs with incredible momentum.
However, the increasing volatility suggests there may be only one more weekly bar where gold puts on such massive moves as $50, $70, or even $100 in a week. (When volatility starts to expand, that's typically a sign of an interim top as momentum like this can’t continue forever.)
But the gold bull is very much alive and well even if we do see a consolidation or correction. I would view any pullback as an opportunity to go long. I don't think the current crash in the dollar or interest rate yields is a short-term thing. Instead, these events have set in motion a number of things including higher metals prices over the course of time.
Buy gold and buy silver on any dips.
Now here’s the NASDAQ stock index:
This index is trading near multi-week highs at a resistance area.
It went higher on robust earnings from Amazon, Apple, and Facebook, but because of that resistance area, I would careful about when we get new highs.
That’s because the NASDAQ is trading beyond the apex of its long-term ascending broadening formation. Be careful at current levels.
Whereas the NASDAQ has smoked through its previous highs in January, you can see that the Dow Jones Industrial Average (DJIA) hasn’t joined it:
The DJIA remains within a small symmetrical triangle. Whether it goes higher or lower from here should dictate how the other stock indexes are likely to respond in the next couple of weeks.
That’s why I’m watching the current inflection area in DJIA very carefully. That triangle is getting more and more narrow and if the breakout is to the upside, it's likely that this great big bull market is going to continue. On the other hand, a breakdown suggests a setback in the short term.
And that’s it for this week.
To summarize, I’m cautious about August’s reputation for consolidations with little meaningful price action. However, I remain bearish on the dollar and bullish on the precious metals. I’m also looking closely at the yen for a potential major change from strength to weakness against other major currencies.
I wish you a very healthy and prosperous trading week.
Mark "WhateverItTakes" Shawzin