Seven Charts from Last November … You Must See!

Last November, the Fed officially announced its plans for a second round of quantitative easing — better known as QE2. This was a step most experts confidently professed would destroy the dollar.

Despite the bear-mania surrounding the dollar at the time, I saw it differently, especially given the hindsight provided from the Fed’s first adventure with QE.

My conclusion: It was clear that a draconian outcome for the dollar wasn’t in the cards.

So three days after the Fed’s announcement, I showed you seven charts here in Money and Markets that made the case for the buck.

And I’ve been proven right …

In fact, the dollar is higher now against a benchmark basket of currencies than it was before QE2!

Today, as we’ve reached the half-way point of the Fed’s QE2 program, I’d like to revisit those seven charts from November 6, 2010 and look back on how my analysis has played out.

Chart #1:
Long-term dollar cycles

My analysis then: The chart below is the roughly seven-year cycles in the dollar, dating back to the failure of the Bretton Woods system 40 years ago. These cycles argue that a bull cycle in the dollar started in March 2008.

That would put the dollar just 2.6 years into its new bull cycle or a bit more than a third of the way through a typical long-term dollar cycle.

Without question, this recent cycle has been very volatile. But the buck continues to trade comfortably above its 2008 all-time lows and the lows of last year [2009], making higher lows along the way — a bullish pattern.

Here’s what happened: The dollar bottomed a day after the Fed’s formal announcement on QE2 and rose nearly 8 percent in the following weeks. It is still more than 1 percent stronger than it was last November and remains in a multi-year bull cycle.

Chart #2:
10-year dollar chart

My analysis then: The chart below shows the roughly seven-year downtrend in the dollar and the subsequent ascending channel that started in 2008. You can see that the dollar is now testing the bottom line of this bull channel, an attractive area to buy the greenback.

A bounce from these levels would project a move toward the top line of the channel or about 23 percent higher.

Here’s what happened: The dollar continues to hold the bottom line of this ascending channel (in red), which makes it a very attractive, low risk area to BUY dollars.

Chart #3:
10-year euro chart

My analysis then: This chart for the euro is essentially the inverse of the dollar. And here too, you can see a long multi-year trend, higher in the case of the euro, followed by a descending channel.

The euro also is bumping into a technical boundary, one that represents a downward trending channel. A fall from this level of resistance would open up a downside for the euro that would be right on target with most bearish estimates espoused when the euro zone was at the height of its crisis … parity versus the dollar.

Here’s what happened: The five-month rally in the euro topped out the day of the Fed’s November QE2 announcement. Over the next two months it fell nearly 10 percent against the dollar. And the world’s focus quickly turned back to the European sovereign debt crisis.

Since then, the euro has experienced another sharp bounce. But the multi-year downtrend is still well intact, projecting parity versus the dollar — perhaps as early as this year!

Chart #4:
Euro’s 22-week run

My analysis then: For more on the euro, consider this: The euro is in the midst of its strongest 22-week run on record, surpassing its prior record surge in 2003 — both areas are noted in the chart below.

What’s notable here is that in 2003, a 9 percent correction abruptly followed this strong climb. From current levels in the euro, a similar correction would mean a move down to 1.30 over the next few months.

Here’s what happened: The euro didn’t tumble 9 percent … it tumbled almost 10 percent! In just 17 short days in November, the euro fell from over 1.42 to just below 1.30. And it traded as low as 1.2872 against the dollar two months later.

Chart #5:
Pound still weak

My analysis then: Despite all of the fuss over the weak dollar, the British pound is still trading nearly 25 percent weaker against the dollar since the onset of the financial crisis three years ago.

And in the chart above, you can see that while the dollar and the euro are bumping into critical long-term technical areas, so is the pound.

Here’s what happened: The pound also topped out right around the date the Fed formally introduced QE2. And it fell nearly 6 percent in the months following. It still remains 23 percent off of its 2007 highs and is still entrenched in the long-term downtrend (defined by the declining white trendline).

Chart #6:
Yen near all-time highs

My analysis then: Now, for the Japanese yen, the other remaining major currency in the world …

This long-term chart in dollar/yen going back 40-years since the failure of the Bretton Woods system, shows its steady decline.

Even given its recent intervention the pair is nearing all-time lows (lows in the dollar, highs in the yen). From this chart, compared to the charts of the euro and the pound, you can see the lion’s share of dollar weakness over the past few years has come from the surging yen.

And now as this dollar/yen exchange rate nears all-time lows, the Bank of Japan is rolling out its most aggressive deflation-fighting act yet: With more QE, more fiscal policy and a cut in what’s left of its interest rate.

Plus, the Bank of Japan is officially in intervention mode — all things that make a case for a bounce in dollar/yen.

Here’s what happened: The dollar/yen relationship marked a 15-year bottom in the days surrounding the Fed’s QE2 announcement. Since then the dollar has staged a 5 percent run against the yen and continues to hold a stronger position.

Finally …

Chart #7:
Battle against the yuan

My analysis then: With the Fed’s QE2 policy officially on the table, the emerging market and Asian countries that have been waging a fight to keep their currencies from a runaway surge have already stepped up with more currency market intervention and talks of capital controls.

And they are doing so because the dollar is weakening. But more importantly they’re reacting because the Chinese yuan is getting weaker relative to their currencies in the process — a competitive disadvantage for their export trade.

Here’s what happened: Many of these countries have continued aggressive action to limit strength in their currencies. Meanwhile, the Chinese have continued to show resistance to any meaningful appreciation in the yuan — a dynamic I expect will continue, despite all of the expert predictions of a big one-off revaluation in the yuan to come.

To sum it up: The Fed’s decision to embark on another quantitative easing campaign dominated the world’s global markets for months in the third quarter of 2010. And most market chatter was squarely surrounding a doomsday scenario for the dollar. But it hasn’t played out that way.

My point in that November 6 column was this:

“A grossly weaker dollar is not an economically or politically acceptable proposition for the world. And trouble for the world economy represents trouble for the U.S. economy.

“So, despite all of the bold projections of a continued rout in the dollar, these seven charts suggest the exact opposite outcome could be around the corner.”

What’s the key takeaway today? All of this analysis still holds.

Regards,

Bryan

P.S. I see a lot of volatility ahead for all major currencies, including the dollar, euro, pound, yen and yuan. And that volatility can mean boatloads of profits for my World Currency Trader members. To see how you can join them, click here to view my latest presentation.