(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)
The U.S. dollar Index has broken a critical technical support level that could lead to a sharp decline, according to a technical analysis, falling as much as 13 percent from current levels. That retreat promises to boost stocks, oil, gold and affect other asset classes.
This is a dramatic turnaround from a few months ago when U.S. Treasury yields and the dollar jumped following the election of Donald Trump as President on November 8. Back then, investors anticipated an accelerated expansion of the economy at a pace of 3-to-4 percent yearly. But optimism has faded that Trump can achieve this goal anytime soon, if at all. Couple that with the Fed’s plans to scale back the pace and size of rate hikes, which has caused yields, and therefore the dollar, to reverse.
On a technical basis, the dollar has broken critical support at around 92 and now appears ready to fall by about 13 percent to 80 on the dollar index, as you can see by this chart above. This widely used index tracks the value of the dollar. This trend could boost the euro by nearly 17 percent to $1.40 versus the dollar. It also could affect other classes, pushing up gold by as much as 21 percent to $1,600 and oil by 25 percent to $60 a barrel, while fueling U.S. stocks.
Investopedia also outlines in two separate stories how the weakening dollar is affecting commodities and gold. (See also: 3 Stocks Poised to Soar as Dollar Plunges, and Gold Could Surge 20% as Dollar Retreats.)
A weakening dollar would exert a major impact on the euro, driving the European currency to break above the $1.20 level, the chart above shows. The dollar and euro currently are going in opposite directions. As mentioned, yields falling on the long end of the curve have caused the dollar to weaken. At the same time, investors in Europe see that the region’s improving economy will lead the European Central Bank to remove its accommodative policies. That would cause interest rate spreads between U.S. Treasury yields and yields in Europe to contract further, pressuring the dollar lower.
The chart below compares the U.S. 10-Year Treasury to the 10-Year German bond. We can see how the spread between U.S. and European yields initially widened last fall after the U.S. Election, and then contracted this year as the Fed slowed plans for rate hikes.
The declining dollar’s impact is equally large, though not as obvious, on American Depository Receipts (ADRs), which are denominated in dollars. These instruments allow investors to own a foreign stock on a U.S. exchange through a certificate issued by a U.S. bank representing a specified number of shares.
In the case of ADRs, the weak dollar helps to push the price of ADRs higher. For example, shares of global German enterprise software maker SAP SE (SAP) trade both in Germany and as ADRs on the New York Stock Exchange. With the euro valued at about $1.20 for each dollar, SAP’s German shares and its ADRs in the U.S. trade at parity – or roughly an equal price less the conversion cost. But a falling dollar and a euro rising to $1.40 against the dollar would change that. SAP’s stock price in New York would have to increase significantly to trade at parity with SAP’s share price in Germany.
A weakening dollar also helps U.S. companies with large international sales, enabling them to convert stronger foreign currencies into U.S. dollars, thus boosting revenue and profits. For example, a falling dollar against the euro makes U.S. exports cheaper in Europe. This, enables European consumers to purchase more Nike, Inc. (NKE) athletic wear at cheaper prices, boosting profits when Nike repatriates them back to the U.S. in dollars. For example, every 1 million euros of sneakers that Nike sold in the second quarter at an exchange rate of $1.20 would be worth $1.2 million. But if the euro’s value rose to $1.40 against the dollar, that same 1 million euros would be valued at $1.4 million.
Oil and Gold
A weakening dollar is also supportive of assets like oil and gold as each is priced in the currency. This makes the value of each commodity more expensive because it takes more dollars to buy each unit. Should the dollar weaken as forecast in the prior paragraph, oil could rise to $60, or even higher.
The falling dollar already has exerted a quiet, but dramatic affect across asset classes and the global economy. As it declines further, its affect is likely to be much more pronounced.
Michael Kramer is the Founder of Mott Capital Management and runs MCM’s actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer’s bio and his portfolio’s holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.