Andy Krieger's Thoughts on the Market - 24 January 2024

In my last write-up, I wrote that I expected the dollar to likely come under a renewed attack once the recent corrective cycle was complete. My hunch is that the renewed attack is very imminent. I have sold dollar Swiss and dollar yen today, and I also sold a basket of Canadian dollars, euros, and pounds against the yen and Swiss franc. Why? Let me walk you through my thought process. You might find it to be helpful – either as something to consider in your own analysis, or alternatively as something to avoid. Either way, there is definitely a method to my madness, even though my madness sadly leads to wrong decisions quite a bit.

First of all, if you go back and check the hourly charts, nearly every rally in the dollar since the start of the year took place during New York hours. The pattern has been very clear. New York speculators would aggressively buy the dollar – dollar Swiss and dollar yen in particular – from early morning all the way into the close. Tokyo would knock the dollar down a bit, and then London would bring the dollar back towards the prior day’s closing levels before New York would come in and take the dollar up again to ever-higher levels.

Against the yen, the dollar put in its preliminary high on the 17th of January, less than a week ago. Two days later it made a marginal new high at 148.81, but the move was unconfirmed by basic technical indicators like the RSI and Stochastics. It started really getting my attention at that point.

The price action during subsequent New York sessions became muted, and the dollar started consolidating in the mid-to-high 147.00’s. That was also interesting to me as it seemed that the speculators in New York had their fill of dollar yen (and dollar Swiss) and the exporters and the foreign investors in the Nikkei were happy to buy lots of yen at these levels. It makes sense that they would be happy to sell dollars at these levels since we are only several percent from the highest levels in thirty-four years.

What was driving the fierce buying in New York? Have a look at the following charts. They tell us a lot about what the dollar buyers were thinking. As you can easily see, the chart of the US 10-year yield is remarkably similar to the daily chart of dollar yen. Allowing for a small lag of about fourteen days, the dollar’s top in mid-November mirrored the top in bond yields almost perfectly. The yields topped out first, and then the dollar followed once the trend-following speculators finished getting long at the dollar highs.

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The divergences on the daily chart were screaming “SELL,” but the trend-following players kept buying until finally the dollar broke down very hard in the middle of November. The yields bottomed out at the end of December, and the dollar bottomed out at basically the same time. The market had gotten way too optimistic about interest rate cuts, and we had just seen a huge decline in yields. A bounce in yields was inevitable. A bounce in the dollar was also inevitable. Is the bounce done? Probably.

As you can easily see, the charts mirror each other almost perfectly. The logic behind the carry play is simple – sell yen, buy dollars and hope the dollar doesn’t drop more than a few percent since we earn the interest rate differential between the two currencies. The positioning in carry plays can be quite massive -- many tens of billions of dollars. The players tend to be patient, and they tend to move in herds. It is for that reason that the unwinding of the positions can be quite dramatic. There are obvious levels where the investors will be forced to unwind. The dollar’s low around 140 is one very obvious level. The swing lows last July around 137.25 will be another obvious level. As the dollar breaks below these levels, we should anticipate successive acceleration in the down moves, further fueled by shorter term speculative interest.

By the way, for you fans of divergences, please have a look at the daily chart below in Bitcoin from the 4th of December last year. It was a textbook perfect scenario as the speculators kept driving the price of Bitcoin higher, but the technical indicators were shouting out warnings to every long. I play in Bitcoin sometimes, and that was one of those times. The news about the Bitcoin ETF was the perfect set-up for a buy the rumor, sell the fact scenario. One of my friends sold Bitcoin aggressively when I pointed out the divergences on the chart as Bitcoin was making new multi-year highs. January has been a good month for him.

The chart below is the Bitcoin daily chart which shows the massive divergence that started forming on the 4th of December. The RSI’s were trending lower as Bitcoin was shooting higher. That is typically an unsustainable combination. Either the price needs to have a sharp correction, or the market needs to go sideways for a long time. We got the sharp correction. Is it the start of something bigger? That is a discussion for a different day.

One thing I would like to note is that if my readers have specific questions about specific markets, I will typically try to address their questions in a future write-up. Therefore, you should please feel free to contact Nicholas Puri from The Duomo Initiative with your specific questions and queries.

(Poor Nicholas had to listen to me ramble on and on earlier today about buying the Swiss franc and the yen. I hope he didn’t mind being my sounding board. Sometimes I just need to talk about the markets for a while to help refine my thinking, and Nicholas was my victim today.)

There are other factors driving my thought process here on the dollar, and I will mention them as they are not quite so obvious. Specifically, they relate to liquidity in the system. I like to follow the Fed as it is both amusing and instructive. It is amusing because the Fed’s words and their actions are often at extreme odds with one another. For example, over the past several weeks bank reserves have increased by $346 billion while the Fed’s balance sheet has only been reduced by $8 billion. That doesn’t sound like monetary tightening to me! I wonder what the Fed has in mind when it says it will start to taper its monetary tightening in a couple of months. Monetary loosening is already occurring. This is another factor that will weigh on the dollar.

Although the Fed won’t start aggressively cutting rates this year unless we run into some serious economic headwinds, interest rates will come down. How much? My crystal ball hasn’t come up with a clear answer on that one yet, but I would expect by at least 100 basis points.

Another factor to consider is that Fed showed a loss of $117 billion in 2023. That might seem like a big number, but that is only because the Fed doesn’t show the unrealized losses on its portfolio that are well in excess of $1 trillion!! The Fed will talk tough, but tolerate higher inflation for many reasons, not least of which is because it wants yields lower in order to try to heal its own balance sheet. The commercial banks have huge unrealized losses as well due to their “held to maturity” tax privilege which allows them to mask their losses and give the appearance of profitability. These two factors alone should be enough to incentivize the Fed to push rates lower.

At the same time, the 10-year yield in Japan has surged recently, helping to support the yen and throw cold water on the speculators who want to drive the dollar towards 160.00. Inflationary pressures in Japan seem to be stabilizing just above the 2% level, which is what the Bank of Japan has been pushing for during the past 34 years!! The staggering deflationary cycle in Japan finally seems to be coming to an end, albeit not in a dramatic fashion. There are structural headwinds (aging population, etc.) there that will continue to weigh on inflationary pressures in Japan, but with a surging stock market and a buoyant mood among investors, there is a good chance that Japan will finally emerge from its long-term deflation.

This will lead to the Bank of Japan finally ending its negative interest rate policy, which in turn will lead to some massive unwinding of short yen carry plays. The magnitude of this unwinding will be far greater than we might “rationally” expect, as it could ultimately be the trigger for a new yen bull market that will take dollar yen below 100.00. A move of this magnitude will take several years, but the conditions for this sort of massive mood are in place.

Frankly, even if my timing is off and dollar yen surprises with a spike up through the prior highs around 151.90 and tries to charge back to the 160.00 level – a level last seen in April of 1990 – the final rally will be short-lived and fail dismally. The next major move in dollar yen should be lower – much lower.

The recent surge in stocks has been largely fueled by some excess liquidity in the system. It is unfortunately a situation that perfectly exemplifies the growing disparities in the US economy between the very rich and everyone else. Housing affordability is at an all-time low, and this is a major problem for the youth of today. Stocks are predominantly held by the wealthy. Therefore, the surge in stocks flies directly in the face of an unpleasant reality -- It is simply too expensive for most young workers in the U.S. (and the UK) to afford their own homes. The Fed will bear this in mind when they start to lower rates, but remember, they are also acting out of self-interest. Yes, they will help housing become more affordable with lower interest rates and cheaper borrowing costs, but that is a by-product, not the real driving force behind their thinking.

As we move towards the end of January, we need to be cognizant of some underlying risks to the economy. I want to address these things in my next update as it can be quite confusing to try to untangle all of these different things. They range from geopolitical risks such as supply chain disruptions due to the Red Sea problems to record high office vacancy rates across the U.S. We have a super tight labor market at the same time we have sharply rising credit card delinquencies. We have record levels of credit card debt and a surging stock market while the Fed is preparing to pour gasoline on the fire with lower interest rates. We also will have a wild election year filled with serious levels of acrimonious fighting. Plus, for the first time, the U.S. government will have to pay more than $1 trillion dollars in interest rate costs to cover the national debt. Some of these risks are inflationary, some deflationary. Either way, we need to gird ourselves for a wild ride. 2024 is going to be a crazy year with huge volatility.

Wishing you all the best of luck.

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