Why the Dollar Will be Get Stronger?

The whole market is currently short the dollar right now but I think that could be a big mistake. I know this is a completely contrarian view and that the outlook for the dollar is not good. However, I have 5 good questions and 5 good answers why I think the dollar is headed for a reversal and that this is the perfect time to go long.

1. What good is a strong Euro? I believe a strong Euro will do more damage to Europe than a weak dollar will hurt the U.S. Recently, our weak greenback has been beneficial in two different ways. First by boosting exports and discouraging imports which provides a shot in the arm for our weak economy; not good for the Euro. Second, it helps shrink our trade deposit in goods and services which in turn slows the endless flow of dollars abroad; not good for the Euro.

2. Is there a currency that can replace the dollar as the world’s reserve currency? To this I have to say… into what? Recently China suggested it would diversify away from the dollar to a likely candidate the Euro. However, the Euro doesn’t have enough liquidity to handle the demand. It is still an experimental currency that not one government can invest in with total faith. Also, with more than two-thirds of foreign reserves in dollars, it would most likely take a decade to replace the dollar as the world’s reserve currency.

3. Is there anyone a weak dollar helps in the long run? Even though many countries somewhat dislike Americans, they dislike a really weak dollar even more. Why? A weak dollar makes U.S. exports attractive and forces foreigners to patronize that which they despise. Their manufacturing industries suffer and their unemployment rises. So don’t expect foreign governments to fight a modestly stronger dollar or even encourage it when the reversal begins.

4. What about the stock market? The stock market loves a strong dollar because a weak dollar is NOT beneficial to the stock market. Historically, the average return of the S&P 500 – during times when the dollar was strong – was a gain of 86.6% which is over five times the average return of 16.4% when the dollar was weak.

5. When is the best time to reverse positions in a market? The best time to take a contrarian position in a market is when the most unlikely and unsophisticated are speculating. Give me a break… when corner store owners and housewives start trying to earn extra income by speculating in the Forex, something they know nothing about, we’re near a bottom. The smart money knows that and now you do to.

Yes, the dollar will get strong again; at least moderately. In the near term there will probably be more pressure to the downside. However, a turn is coming and when it does the change will come swiftly.

The NFP and The Markets

The Non-Farm Payroll and Unemployment Reports are considered by most economists to be about the most important economic indicators, and certainly, their immediate aftermath creates a high level of volatility. However, as any trader will tell you, a consistent trend is much easier to profit from than immediate short term movements, so let’s look at the numbers and see if they truly are a help in this regard. The answer will probably surprise you.

As currency traders we of course look at the dollar’s movements but remember, the S&P 500 has a huge amount of influence over where the dollar is going. Actually, the dollar’s relationship with equities is rather a chicken and egg affair-either one can definitely drive the other given the right set of circumstances. For example, the stock market crash which ensued after the Lehman bust last September certainly helped drive the dollar far higher against the higher-yielding currencies while Bernanke’s infamous “electronic printing” comments during his March 15 60 Minutes interview helped push it in the opposite direction and spark a rally in equity markets.

What it really comes down to is investor’s appetite-or lack thereof-for risk. When the investors are risk-averse they move into the dollar and Treasuries as they move away from stocks and commodities while the acceptance of risk has the exact opposite effect. So the real question we need to answer is what if any effect the NFP has on investor’s risk tolerance.

First, the unemployment rate has followed a consistent pattern; it’s worsened each month at a level about as expected. The only exception has been in July when the 0.1 percentage point increase was less than expected. That’s significant because of the way unemployment is measured; workers who are not actively looking for work are not counted in the headline unemployment rate but as they re-enter the job market, they are.

Over January and February, the markets were in risk-averse mode; the S&P 500 lost 9.03% and 10.69% while the dollar index gained 5.46% and 2.53%. The NFP, while certainly bad, was basically about as expected in both reports. In March, the amount of jobs lost continued to worsen but the number was better than what the market was looking for. The S&P gained 9.36% while the dollar index fell 2.92%. The April loss of jobs worsened about as expected as the S&P gained 10.52% and the dollar index fell 0.94%. The tide turned in May when the loss of jobs declined for the first time, beating market expectations. The S&P gained 5.21% while DXY fell 6.22%. The June loss of jobs was far better than expected while the S&P was basically flat and the dollar gained 0.84%. Finally, in July the job loss was far worse than the market was looking for, but he S&P still managed to gain a very healthy7.22% while the dollar fell 2.27%.

The only conclusion that I can draw from the numbers is that the NFP itself is actually a poor predictor for market risk tolerance over the subsequent month, with the proviso that the market is betting that job losses peaked in April at -663k. It seems to be that the unemployment rate carries more weight with investors, especially given what happened in July when stocks rose when the loss of jobs accelerated as the unemployment rate grew less than expected.

Meanwhile, the latest data on unemployment claims shows a decidedly mixed picture when you look a bit deeper into the data. The number of people continuing to claim benefits rose by 69,000 to 6.31M while the 4-week moving average decreased by 148,500 to 6.427M. Economists prefer to use the 4 week averages in this series because they smooth the data however, the number of workers continuing to claim benefits will fall as they run out unemployment insurance, which is happening now.