A catalyst for working off the market’s over-extended and over-bought conditions remains elusive. The Federal Reserve’s latest monetary policy statement essentially blessed the market’s stubborn “melt-up.” The statement did not provide the incremental “hawkishness” as I was expecting given last month’s surprise discount rate hike. In fact, this statement’s reference to low rates for an “extended period” further confirms Chairman Bernanke’s insistence that the Federal Reserve is not tightening monetary policy. This statement must discourage anyone looking for more support for the dollar to re-energize its 3-month relief rally. Now, there is every reason to expect that the dollar has topped out here at the resistance formed by the June highs (see chart below). Moreover, the euro is stabilizing, and S&P removed Greece from “creditwatch” (although the outlook for its rating on Greece remains negative).
*Chart created using TeleChart:
The dollar still has a fundamental problem in that traders think of it more as a fuzzy, warm blanket when times look tough and not as a currency with strong underlying fundamentals. At this stage, the path of least resistance for the dollar is down until the threat of rate hikes becomes more salient. (Granted most of the world’s developed economies still prefer to devalue against the dollar – the latest example was Japanese Prime Minister Yukio Hatoyama’s attempt on Friday to talk down the yen). In parallel, the path of least resistance for the stock market remains (melt-)up until some new catalyst arrives.
The Australian dollar remains my favorite currency to play against the U.S. dollar (note that the Aussie dollar is not included in the dollar index). I think it is finally ready to re-challenge the 52-week highs established in November. I am neutral on playing commodities against the dollar here.
Be careful out there!
Full disclosure: long FXA