Stronger USD to Keep Growth in Check

Stronger USD to Keep Growth in Check

By: Simon Furman | Where To Trade | On:17-10-2014 09:25
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Key Highlights

  • Small businesses are less confident
  • Poor report on advance retail sales for September
  • Strong USD tapering Economic growth
  • Time to take profits on long USD positions

 

EURUSD 

In the third quarter of 2014, there was a significant increase in the net long positions of the dollar in the futures market this was a response to the strong reports on the economy that were being released. We saw the EURUSD plummet from the 1.32 exchange rate to the current levels at 1.28 while the cable simultaneously fell in that period to below the 1.60 major level. The market is ready to see the dollar continue with its rally against other currencies as traders who had caught the rally are evaluating the next potential direction for the USD.

 

Where To Trade - Average EURUSD Daily

Figure 1 Average EURUSD Exchange Rate

 

At this stage all eyes are on the economic data being released for Q3. We know that growth at 4.6% for Q2 was remarkably strong; will that strength be shown for Q3? A Strong report for Q3 will be the perfect combination of factors to see a major rally for the dollar.

We are still anticipating that Yellen will announce an end to the quantitative easing program later in this quarter as the monetary policy in the US normalizes. If this tightening of policy is matched by strong GDP growth reports for Q3, The USD bulls will have a field day. Strong growth and a tight monetary policy will undoubtedly see the USDX soar above the current levels. We are currently analyzing every significant economic report that is released as the markets assess whether the current levels for the dollar are tenable in the medium term.

On Tuesday, a little known but important sentiment index, the NFIB small business optimism index for September was one of the first clues we had of what the real economy was doing at the end of Q3. The index has dropped from 96.1 to 95.3.This shows that small businesses in the US are less optimistic about their economic prospects than they were the previous month.  Falling confidence usually precedes poor profits projections emanating from poor sales performance.

On Wednesday, the advance retail sales report for September confirmed the cause of the confidence to lower. We had a -0.3% (negative 0.3) change in retail sales down from the previous reading of 0.6% the previous month. This represents a contraction in the US consumer spending habits despite the low unemployment in the US. Even when we exclude the sale of gas products and automobiles (taking into consideration the falling oil prices) the September Retail sales still show a contraction of -0.1 (negative 0.1) down from the previous month which had a 0.5% reading. We must also notice the negative percentage change in business inventories. This coincides with lowered confidence that businesses are expressing, they anticipate even less sales going forward.

 

Putting it all together

We cannot account for the dramatic contraction in sales using the falling gasoline prices or other commodity prices alone. A stronger dollar will hurt the trade account by making exports more exports more expensive, this lowers sales and acts as a natural check on growth. Currently, the dollar is near its pre-crises levels, it will take time before the markets readjusts to a strong dollar, in the meantime, the strong dollar will tapper the growth of the economy even without further tightening of the monetary policy.

Tentatively, we expect the GDP growth in Q3 to be muted compared to 4.6%, of course more data will make this picture clearer. Under these conditions, we should anticipate the USD to keep on appreciating but at a less dramatic pace than the one we had in Q3. We should also anticipate more ranges and bigger retracements on the way. A great approach is to take profits from the previous Long USD trades and to buy its dips going forward.

Simon Furman

Simon Furman

Think Global - Act Local

Simon Furman is one of the best financial analyst with 27 years of trading experience

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