Welcome to 2018....What's next for USD?

The financial community returned today from its December slumber to whack the dollar. After finally posting a year of above expectations growth, and three hikes from the FOMC, the currency is again the one the one traders love to hate.   I don’t have a decent way to illustrate this, but I think it is fair to say short USD is a consensus trade going into the new year.

Fundamentally, it makes sense. I believe we are seeing a phase of increased industrial activity after a LONG cycle of destocking and creative destruction of global excess capacity. As such, US manufacturing PMI has been moving higher consistently throughout the last year.



But that’s nothing compared to the resurgence in other advanced economies, which is a combination of the rebirth of growth in Europe--led by Germany, but far more evenly spread than any other time this decade--but also from Japan, where the economy is showing some signs of life that haven’t been seen in this trading lifetime.


On valuation, despite the dollar’s poor 2017, it is still well above the 2013-2014 levels. This poorly formatted chart blends these two ideas together--the significant short position from spec accounts on the LHS, and the TWI on the RHS...Still plenty of space for traders to get paid here.


Drilling into the technical data a little further--there is a significant dispersion in trading positions, despite the short USD bias.  On a 3yr z-score, GBP and RUB are at significantly stretched long positions, while years of high rates and over-valuation has finally caught up to NZD. Similarly, AUD seems to be suffering from weak local data and some reluctance to bet on China keeping the machine cranking at full speed.

(And I can’t help but notice BRL at a 3yr short extreme while MXN whistles along at the middle of the range, but we’ll save that for another post!)

And then there is JPY. I’ve alluded to this before but really never got excited about it...the yen has confounded me for years because it is just so tough to get a clear shot on what to expect from the authorities there. Yeah, I get it...Abe and the BoJ are incentivized to let the yen stay cheap and keep the monetary petal to the medal. But that has a limit when recent performance looks like this.


Combine that with the short position in the market and attractive risk-off dynamics...and yeah, long JPY  makes some sense here, at least to converge with regional performance, if not for a more structural appreciation if the BoJ shows any signs of raising interest rate targeting or easing QE programs at large.

For all the bearish views on the dollar, it is amazing that there is such a negative view of rates. Sure, the view on the dollar is driven by global growth, which presumably should lead to higher global interest rates. But the  short view--if not positions--still seem largely confined to UST.

That’s pretty amazing when you look at this chart...despite the move towards 2.5% last week there is still a reluctance to break out to higher yields...and vol continues to skulk around in the gutter.


Short positioning amid strong fundamentals and historically low vol….Someday, somewhere, someone is going to make money on a long vol position. I just don’t know when.

Today’s post by Brad Sester at Follow the Money had some good points on the relative importance of Chinese flows and European flows into the US bond market, which brilliantly ties these two markets together. More on that later in the week.
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Gus
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January 2, 2018 at 5:01 PM ×

Shawn .. the formatting to today's post is different, making it difficult to read (at least on my computer). FYI

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Shawn
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January 2, 2018 at 8:36 PM ×

blah...thanks for the head's up!

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johno
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January 2, 2018 at 9:22 PM ×

Thank you for the post and Happy New Year, Shawn.

Looking into future is a tough game. 2017 could be called the slaughter of the idols, looking at the performance of the "big names" in macro. It would be really cool to look six months into the future and have a hit rate north of 70%, but that ain't me, and it sure wasn't the big dogs. Nimbleness is everything; imagined foresight (at least last year) is worse-than-nothing.

USDJPY and the US 10Y are so hard. Haven't made real money in the former since '12-'14. USDJPY seems to be a carry-efficient proxy for the 10Y for some players, but it tracks the real rate better than nominal over time. That's been an issue as the latest pickup in rates is driven by the break-evens. As for the 10Y, that's been even harder to make money in than USDJPY. Seen it argued from both sides, and still no idea (on which I'd bet money) which way it goes. Notable that JPM's strategist Loeys, whom I rate, wrote in his "What have I learned?" [after 30 years] that the "harder [calls] are bond duration, and country and sector selection in equities." That matches up with my personal experience (although I am loving this Chinese internet stock action today!).

Good luck, all.

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January 2, 2018 at 10:10 PM ×

Not to mention the majors having twin surpluses to the US twin deficits. Then look at valuation based on PPI differentials. Long Euro and commodity currencies is my play. Rates weren't the story last year and won't be the story this year.

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January 3, 2018 at 3:03 AM ×

the case for a stronger USD is that of an exogenous shock--the fed. there's a possibility we get a more aggressive hiking cycle than expected--2 hikes priced now, could we get to 4? it's still probably a stretch, at least given current composition marginally more hawkish than last year. the next shock would be a john taylor or taylor-lite governor appointment.

but my expectation is unfortunately quite consensus: the us is fairly late cycle, with the real rate approaching r* (probably! we don't know because the error bounds on the estimate make it nearly useless!). europe is approaching an inflection point where growth is sustained enough for the ecb to get comfortable with the asset purchase program ending on current schedule in september.

the best way to play these imo are high carry em currencies, em hy credit, and commodities like william alludes to in the previous comment. cad and nok probably look the most attractive -- one central bank that is actually hiking, and one that keeps making noises like they're ahead of the market in their timing for a first hike.

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johno
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January 3, 2018 at 10:56 PM ×

One question concerning USDJPY I may have posed before is what happens if we get inflation >1% in Japan. Some argue that YCC will remain, or slowly adjust, pushing real rates down and with it the currency. Others argue markets will look forward, anticipating removal of YCC, higher rates, and pushing the currency stronger. Any thoughts here? If USDJPY starts moving lower in the latter scenario, while US yields move higher, there is a juicy correlation trade to be done. The case of EURUSD in 2017 would suggest the latter scenario playing out, no?

The days leading into and first day of the year really crushed the dollar bulls. You know, these guys who go on and on about "the dollar." Wrong, wrong, wrong, and still, "the dollar" this and "the dollar" that. For months, and months, and months, all the while we wonder, "when will you just stop?" (to be fair, readers here may have had the same thought about me and my decidedly wrong NOK views, though shockingly, my closed positions for last year in NOK were net profitable, as are my open positions) The xccy basis snapped right back at the year's turn, just whacking that leg out from whatever shambles remains of their arguments too (this whole "dollar shortage, blah, blah, EM is a house of cards, blah, blah, it's going to be awful, blah, blah" meme). And with that, I actually bought some USDCHF today. I'm bullish the Italian election outcome but I'm just not ready to gamble on a EURUSD break higher yet, so adding CHF short exposure after some options expired in Dec seemed better against USD. Maybe tomorrow proves me wrong.

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johno
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January 4, 2018 at 3:26 PM ×

Ding! First wrong trade of the year. Should have stuck to EURCHF top add to CHF short.

Given that EUR may be breaking higher, 1-month vol in EURUSD doesn't seem unreasonable.

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IPA
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January 4, 2018 at 7:22 PM ×

The Crude Oil trade is over. Out of everything, including WTI, XLE, XOP and OIH.

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IPA
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January 4, 2018 at 7:28 PM ×

Would like to get back into XOP only on (10%-ish) pullback with a tight stop.

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johno
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January 4, 2018 at 8:56 PM ×

Well done, IPA.

USDPEN has finally broken through the floor the central bank held all of last year. Maybe some catch up to peers there yet.

Bucking the trend the last two days in EM has been USDARS. Makes sense to me -- the central bank's policy shift drove a stake through my thesis and I took the opportunity post the 28th puke to exit LEBACs.

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IPA
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January 5, 2018 at 2:35 AM ×

Thanks, johno. Concentrating my attention on gold at the moment. Seasonal trade, and if '17 is any guide, it is about $60 short of the first major scaleout target, albeit probably closer to mid-Feb. Clearing $1,310 was crucial, imho.

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January 5, 2018 at 6:42 AM ×

Out of all NY trades. Never felt better. This has thrown me back to the time I was living on my Dads and brothers lounge when I was 16 and laying carpet for a living. That was only short term though, until I became familiar with the surrounding market place. I was out of there before Christmas before I lost the touch, and back finding winners.

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Buy Stocks
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January 5, 2018 at 11:50 AM ×

Donald J. Trump (Verified account) @realDonaldTrump 11 minutes ago

"Dow goes from 18,589 on November 9, 2016, to 25,075 today, for a new all-time Record. Jumped 1000 points in last 5 weeks, Record fastest 1000 point move in history. This is all about the Make America Great Again agenda! Jobs, Jobs, Jobs. Six trillion dollars in value created!"


Still long stocks. (Always long. Never short). Time for you macro boys to get long and start making some money like me - Make America Great Again! LOL

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January 5, 2018 at 11:58 AM ×

Trumpy's book comes out next week.



"Inside the Whitehouse: The Art of Losing A Winning Hand"


PS: you just don't see it yet.

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Buy Stocks
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January 5, 2018 at 12:09 PM ×

https://www.zerohedge.com/news/2018-01-05/relentless-stock-market-meltup-smashes-records-around-globe

Stock markets everywhere making, or close to making all time highs (as I've correctly been predicting for over a year here).

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Buy Stocks
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January 5, 2018 at 9:09 PM ×

You macro boys are a joke. Why don't you trade equities with me in a real man's market? Look stocks are never coming down in our lifetimes... Central Banks are printing free money for those of us with balls big enough to go pick it up. Look, here's the Dow up another 200 points in the last couple of hours. LOL. This is the easiest money I've ever made.

I'm gonna send a crate or 2 of Cristal to the Fed later, only fair since they paid for it !

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IPA
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January 5, 2018 at 11:19 PM ×

BS, you may have gotten a wrong impression that this is a medical site. We don't inspect the size of balls nor care whether you have them at all. Also, we can't be "always long and never short equities" as it messes up the asset allocation formula. No pal, not the formula you drink in your crib, the other one. If you care to stop pissing your champagne on the deaf ears of the commenters here, stop your endless bravado, start respecting the people reading and posting here, then maybe, just maybe I'll share the tales with you. "The real men" don't really do what you think they do. They don't unzip their pants to flash the very body part that makes them one. You have no slightest idea what the real men do, kid.

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SRX
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January 6, 2018 at 3:46 AM ×

Kudos! Honestly, this is one of the best posts I've seen on macro man (I've been an avid reader since c. 2007). Shawn (or anyone else) I have the dumb, can you explain how I should interpret the third chart? ("Chart 2"). I can't seem to get my head around what the chart says and what you conclude.

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IPA
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January 7, 2018 at 2:33 AM ×

Shawn, the more I look at the chart the more I believe in my DXY call to hit 88 and eventually 84. There is just so much vacuum below 91. No real support until 88. That would make me enough dough to call it a very successful trade (which is already way in the money). 84 would just be a cherry on top. When I predicted the decline you had many doubts. Are you warming up to the idea?

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January 7, 2018 at 2:08 PM ×

@johnno Great question about YCC. Can I answer with a question? At what point are central bank actions less relevant and the bigger story becomes valuation (PPP) and the twin surpluses?

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johno
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January 7, 2018 at 10:53 PM ×

For avoidance of doubt, when I wrote about "these guys who go on and on about 'the dollar,'" I was not referring to Shawn, who's sensible about these things. Too polite to say who, of course.

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Shawn
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January 8, 2018 at 3:22 PM ×

@IPA....yes I am warming up to the idea. Maybe I'm gonna be the last guy on this train right before it derails into a financial crisis. I can't shake the idea that the yen is set for a move towards 100, throwing something together on that...not a lot of new ideas but I think it illustrates the combo of 1) usd still expensive, 2) jpy still cheap (on PPP at William Buelow implies, relative labor/capex costs, and REER), 3) local (Jpn) fundamentals strong and strengthening, 4) tech position very favorable for long JPY.

@Johno...a local trader in Buenos Aries told me "there is a war between the govt and central bank. the central bank lost." Pretty much sums it up. I think they were a little rash here in letting the peso plummet like this, but again...I don't get a vote.

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Shawn
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January 8, 2018 at 3:29 PM ×

@SRX....thanks, much appreciated...per your question, "Chart 2" is something I borrowed from the research folks at JP Morgan, who have a habit of making their points with engineering-grade prose and visualizations. The chart shows the USD index on one scale, with a weighted average of speculative positioning on the other. the point was to illustrate that while speculative traders on futures exchanges are short dollars, the valuation of USD still looks rich relative to a few years ago, and at most points in history, as today's post will show.

If you don't believe me, ask IPA, he'll tell you!

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boonmee
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January 10, 2018 at 3:59 AM × This comment has been removed by the author.
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