Should You Invest In USD in 2016 Or Not

Should You Invest In USD in 2016 Or Not

2015 was an excellent year for the U.S. dollar.  However, with just 5 trading days remaining, many investors wonder if will still be a smart trade in 2016 to be long on dollars.  The month of December has been difficult, with dollar bulls struggling to stay in control.  Interest rates have been raised for the very first time by the Federal Reserve since June 2006.  However, instead of the dollar appreciating, it erased most of its gains from November.  Many investors are now wondering if the dollar can’t be lifted by hawkish forward guidance and a rate hike, whether or not it is a foolish idea to purchase greenbacks in 2016.

In order to answer this question, it is important to understand the reason why investors were selling dollars during the month of December.  One of the most crowded trades in the world was betting the dollar would be rising in 2015.  According to the Commitment of Traders report from the CFTC, forex futures traders quickly made adjustments to their positions prior to the FOMC meeting held on December 16.  The largest changes were seen in the yen and euro, where investors were cutting their short yen and short euro positions aggressively.  It means investors were starting to unwind the long dollar trades they had prior to the FOMC.  Then based on what the price action was following the meeting, was further liquidated following the rate hike.  In 2015 purchasing dollars turned in a very crowded trade, and by the end of the year a large amount of money moved over to the sidelines.  What that means for 2016 is that there money available for putting into play once again.

However, positioning wasn’t the only reason investors had for bailing from the greenback.  The following chart shows that tightening cycles in the past haven’t been good news for the dollar.  Many investors have been scared off by this.  Although USD/JPY usually appreciated as it lead up to a rate hShould You Invest In USD in 2016 Or Notike, on several occasions its course was reversed after tightening.  However, with this cycle things are different since the first couple months of the year are going to be good for the dollar and U.S. economy.  The low gas prices and warm weather brought by El Nino will give consumer consumption  a boost, which is supported already by consumer borrowing, wage growth and steady job creation.  New hawks are also being welcome to the Fed’s FOMC voter roster.

However, let us be clear first.  A recession is not going to be caused by the Fed’s rate hikes.  During the second part of the year it might slow the economy down.  However, it is highly unlikely there will be a contraction.
There are some investors that are worried that the Fed’s recent move might end up triggering a recession.  However, there are few indications of this and low oil prices haven’t ever caused a U.S. downturn.  This of course could change if the Fed moves too quickly on raising interest rates.  One of the most difficult challenges comes from the fact that the economy isn’t hit in predictable ways by higher interest rates.  It takes some time for them to really percolate and it can be quite hard predicting the point where the impact shifts from being mild over to severe.  The recent quarter point increase is just a small rate tweak.  Even if were to be increased by an additional 50 to 75 bp by next year (the scenario we prefer), it would still have a limited impact on investment and consumer spending due to the fact that, unlike Europe, a majority of U.S. mortgages are fixed rate.  Businesses could also view the tightening by the Fed as a sign of having confidence in the economy, and they might end up being slow to make adjustments to their investments.  So the greatest impact at the onset will be with the U.S. dollar.

More Hawks inside the Birdcage for 2016 – The dollar’s performance hinges on when the interest rates will be raised again by the Federal Reserve.  January 26-27 is when the next meeting will be held, and there is a zero chance of rates being increased during the first couple of weeks in the New Year, so it is likely that there will be consolidation in the dollar.  However, if an optimistic view of the economy is maintained by the Fed, then there will be growing expectations of a rate hike, which will lead to the greenback having renewed strength.  It is very important to realize that there is a new Fed Presidents group each year. Four votes will rotate in 2016.  One dove and 4 hawks will be replacing 2 neutrals, 1 dove and 1 hawk.  So more consistent tightening is where the balance swings to.  Although the dollar is rich, the path of least resistance we believe will still behigher during the year’s first half.  For the second part of 2016, our outlook changes.  that is when we think the strong dollar and rate hikes will lead to the Fed being force to slow down their pace when it comes to tightening, which marks the bottom for all of the other major currencies and the top for the dollar.

Election years tend to be good for the dollar.  In our table below we show that during election hears the Dollar Index shows an average 5% increase, and that the index has risen 8 of the last 10 time periods.  In one of the two years where there was a decline in the Dollar Index, the greenback has an approximate 0.5% loss.  Although there could be an argument made for Fed policy not being affected by elections, it is true that shifts in major monetary policy have coincided frequently with presidential elections.  The Washington Post created the second chart, and although only 6 election cycles are covered by their data, there is most definitely a noteworthy trend.

Technically speaking, it appears there is a double top that is forming within the Dollar Index.  With 96 being a fairly significant level of support it should be able to hold.  We are also expecting the index to make an additional run at 100.  Following that it should be testing the 61.8% Fibonacci retracement near 102 from the 2001-2008 decline.

Leave a Reply

Your email address will not be published. Required fields are marked *