Cool Video: Is the Third Major Dollar Rally Since Bretton Woods Over?

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Marc Chandler
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To many, the question about the fate of the third major dollar rally since the end of Bretton Woods was resolved last year. The dollar fell broadly. It marked the end the greenback’s ride higher.

However, I remain less convinced that this is really the case.  And that is what I discuss in this three-minute clip from Bloomberg’s What’d You Miss. What I focused on (here) was two-fold.  First, that the dollar’s decline remains within the parameters of what technicians would regard as a correction.

After a trend, there is a counter-trend that goes in the opposite direction. Sometimes it is a correction and sometimes it is a new trend. The question is how to distinguish between the two, and here macroeconomic analysis may not be helpful. Going back to ancient rice traders in Asia, certain proportions have been used. These days the Fibonacci ratios are commonly used. The most important of these are 38.2%, 50%, and 61.8%.

The euro has not retraced 50% of its losses since the peak in the middle of 2014. Sterling has not even retraced 38.2% of its decline since then.

I suggest in this clip that last year was more about European politics than macroeconomic drivers. After a rallying strongly in Q4 16, the dollar moved sideways in early 2017. When it became clear that the populist-nationalist wave was not going to sweep across Europe, the market began correcting the dollar’s rally.

Over time, I expect the macroeconomic fundamentals to reassert themselves. The key is interest rate differentials and the divergence of monetary policy that still has more than a year to run. Now add in the fiscal stimulus with the tighter monetary policy, and that policy mix is among the most beneficial for a currency.

Many observers seem to be curve fitting in the sense that they explain the currency movement by emphasizing short-run correlations. One day it is real interest rates. Another day it is growth differentials. Some days it the external imbalance. Other times, it is inflation or inflation expectations. It is ad hocery at its best.

This is not a robust explanatory model of currency movement. On the other hand, past dollar cycles can be explained by interest rate differentials, policy mixes, and the attractiveness of the investment climate. I think these considerations are still constructive for the dollar.