A currency war has begun….


Spot Gold

The Federal Reserve, Bank of England, European Central Bank and Bank of Japan all expanded their balance sheets (commonly referred to as quantitative easing or QE for short) post-2008 to counteract a contracting money supply and prevent a deflationary spiral. These actions also have the beneficial effect of weakening the currency and improving international competitiveness.

China was considered immune because of its persistent current account surplus and $4 Trillion in foreign reserves. But the recent sharp contraction in Chinese exports to the EU suggest otherwise.

The People’s Bank of China (PBOC) responded by effectively devaluing the Yuan. So far the “one-off adjustment” has been repeated on three consecutive days.

USDCNY

The Euro appreciated considerably against the US dollar as CNY carry trades are unwound.

EURUSD

Gold broke out of its narrow rectangle between $1080 and $1100 per ounce as investors scuttled to the safety of bullion.

Spot Gold

* Target calculation: 1100 – ( 1200 – 1100 ) = 1000

The Yen displays little net gain or loss.

USDJPY

The Dollar Index does not include China’s Yuan and is falling primarily because of the Euro. The Broad Trade-Weighted Index which includes the Yuan is calculated weekly; so it will take a few days before we can assess the impact.

Dollar Index

Competing devaluations are likely to continue as each state (or trading block) attempts to maintain an export surplus. This is a zero sum game, so each action will inevitably elicit an equivalent response from major trading partners. Currency markets are awash with vast sums of liquid capital and an estimated $9 Trillion in carry trades (where hedge funds borrow in a low-interest-rate currency and invest in another at higher rates). Any beggar-thy-neighbor escalation is likely to destabilize financial markets and the precarious balance may prove difficult to restore.

During the 1997 Asian Financial Crisis George Soros called for international regulation of financial markets to prevent a reoccurrence.

It is time to recognize that financial markets are inherently unstable. Imposing market discipline means imposing instability, and how much instability can society take? …. To put it bluntly, the choice confronting us is whether we will regulate global financial markets internationally or leave it to each individual state to protect its interests as best it can. The latter course will surely lead to the breakdown of the gigantic circulatory system, which goes under the name of global capitalism.

~ George Soros: The Crisis of Global Capitalism (1998)


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Dollar strengthens on low inflation

Core CPI continues to hover below the Fed’s 2.0% target, while plunging oil prices keep the broad index close to zero. Core CPI is likely to weaken as the beneficial effect of lower energy costs flows through to all sectors of the economy.

CPI and Core CPI

We often read of the threat of impending deflation — which may well occur. But one needs to differentiate between deflation caused by a surge in aggregate supply, as in the present situation, and a fall in aggregate demand as in 2008. The former may well act as a stimulus to the global economy, while the latter threatens a negative feedback loop between income and consumption which can lead to substantial falls in output.

Low inflation takes pressure off the Fed to raise interest rates but we can expect the first increment later this year. 10-Year Treasury yields respected the rising trendline and support at 2.10%, suggesting another test of 2.50%.

10-Year Treasury Yields

The higher trough on the Dollar Index indicates buying pressure and breakout above 98 would signal another test of 100. In the longer term, breakout above 100 would signal resumption of the primary up-trend but is likely to meet push-back from the Fed as a higher dollar would hurt both exporters and domestic producers competing against imports.

Dollar Index

Hint of Greek bailout revives rates (and the Dollar)

10-Year Treasury yields rallied on hint of a Greek bailout, although Tsipras still has to obtain approval from the Greek parliament. Breakout above 2.50% would offer an immediate target of 2.75% but the advance is likely to test major resistance at 3.00% in the longer term. Reversal below 2.25% is unlikely (unless there is a breakdown Greek/EZ negotiations) but would re-test the rising trendline at 2.10%.

10-Year Treasury Yields

The Dollar Index also rallied. Breakout above 97.5 would suggest another advance; confirmed if resistance at 100 is broken. Reversal below 93 is most unlikely but would warn of a primary down-trend.

Dollar Index

* Target calculation: 100 + ( 100 – 93 ) = 107

Dollar calm while prospect of rate rise fades

The Dollar Index penetrated its descending trendline, indicating the recent correction is over, but the latest red candle warns of uncertainty. Reversal below 95 would warn of another test of primary support at 93. A weaker Dollar would boost demand for gold and lift the US economy, enhancing the competitiveness of exporters and local manufacturers facing competition in domestic markets.

Dollar Index

10-Year Treasury yields retreated below support at 2.25% as turmoil in Europe (Greece) and China reduce the prospect of rate rises. Expect support at 2.10% and the rising trendline. Breach of support is unlikely, but a Fed retreat on rate hikes would warn of serious upheaval in financial markets.

10-Year Treasury Yields

Gold, silver and the Dollar

A long-term chart of silver shows strong support at $15/ounce. Recovery above $18 and 13-week Twiggs Momentum above zero would suggest that the precious metal has bottomed. A bullish sign for gold.

Silver

The picture for gold is less clear, with further tests of primary support at $1140/ounce expected. 13-Week Twiggs Momentum is also rising and recovery above zero would be a bullish sign. But breakout above $1300 is unlikely at present. Breach of support at $1140 would offer a target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Stocks of major gold producers like Barrick Gold remain bearish.

Barrick Gold

The Dollar Index respected its declining trendline, warning of another test of primary support at 93. Breach of support would signal a primary down-trend. A weaker Dollar would boost demand for gold and lift the US economy, enhancing the competitiveness of exporters and local manufacturers facing competition in domestic markets.

Dollar Index

Long-term interest rates are rising, however, and provide support for the Dollar. 10-Year Treasury yields respected their new support level at 2.25% and are likely to test long-term resistance at 3.0 percent. Rising 13-week Twiggs Momentum above zero, strengthens the signal.

10-Year Treasury Yields

Dollar decline

A declining dollar is the one measure supporting demand for gold. The Dollar Index broke support at 95, warning of a test of the primary level at 93. Decline of 13-Week Twiggs Momentum below zero would warn of a primary down-trend. Breach of primary support would confirm, offering a target of 88*.

Dollar Index

* Target calculation: 93 – ( 98 – 93 ) = 88

A declining dollar would be good news for the US economy, improving the competitiveness of exporters in global markets and local manufacturers competing against imports in domestic markets.

Gold breaks $1180 support

Core CPI continues to track close to the Fed target of 2.0 percent (CPI All Items is distorted by falling oil prices).

CPI and Core CPI

Long-term interest rates are in a primary up-trend, with 10-year Treasury note yields breakout above resistance at 2.25% offering a target of 3.0 percent. Rising 13-week Twiggs Momentum above zero strengthens the signal.

10-Year Treasury Yields

The Dollar Index continues to test support at 95. Breach would warn of a test of the primary level (and rising trendline) at 93. A sharp decline on 13-Week Twiggs Momentum indicates this is likely.

Dollar Index

Gold

A weakening dollar would boost demand for gold, but rising interest rates counter this. Spot gold broke medium-term support at $1180/ounce, warning of a test of the primary level at $1140. 13-Week Twiggs Momentum peaks below zero suggest continuation of the primary down-trend. Failure of $1140 would offer a long-term target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Treasury yields surge but Dollar falls

10-year Treasury yields broke through resistance at 2.25%, offering a medium-term target of 2.65%*. Breakout above primary resistance at 3.00% is remote at present, but would signal the end of the secular down-trend (bull market in bonds). It appears that bond investors are reducing their exposure in anticipation of this occurring. Expect retracement to test the new support level at 2.25%; respect would confirm the breakout. Rising 13-week Twiggs Momentum above zero also strengthens the signal.

10-Year Treasury Yields

* Target calculation: 2.25 + ( 2.25 – 1.85 ) = 2.65

The Dollar Index is retreating despite rising bond yields. Declining 13-Week Twiggs Momentum warns of a test of primary support at 93. Breach of medium-term support at 95 would strengthen the signal. Respect is less likely, but would suggest another test of 100.

Dollar Index

Inflation steady while Gold tests support

CPI continues below zero, but core CPI (excluding food and energy) came in at 1.81% for April 2015, indicating long-term inflationary pressures are constant.

CPI and Core CPI

Low inflation relieves upward pressure on bond yields. The yield on 10-year Treasury notes encountered resistance at 2.25%, with tall shadows on the last 3 weekly candles. Expect another retracement to test support at 1.85%. Reversal of 13-week Twiggs Momentum below zero would strengthen the signal.

10-Year Treasury Yields

* Target calculation: 2.25 + ( 2.25 – 1.85 ) = 2.65

The Dollar Index broke resistance at 96 despite falling bond yields, indicating the correction is over and another test of 100 likely. 13-Week Twiggs Momentum is declining, but recovery above the descending trendline would support the (bull) signal. Reversal below 96 is unlikely, but would test support at 93.

Dollar Index

Gold

The inflation-adjusted price of gold (gold/CPI) suggests that gold has further to fall. Unusually high levels of intervention by central banks in financial markets may, however, be fueling support at current prices — suggesting a gradual decline rather than a sharp adjustment.

Gold/CPI

Spot gold is headed for another test of medium-term support at $1180/ounce after respecting resistance at $1220. Breach of support would test the primary level at $1140. 13-Week Twiggs Momentum peaks below zero suggest a primary down-trend. Failure of $1140 would test the long-term target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Gold, inflation and the Dollar

The (5-year) inflation breakeven (Treasury yield – TIPS) recovered from the oil price fall to post 1.66% on May 8.

5-Year Inflation Breakeven

Growth in average hourly earnings (manufacturing – production and non-supervisory employees) also recovered to 1.49% at the end of April.

Average Hourly Earnings

The stronger inflation outlook lifted the yield on 10-year Treasury notes above resistance at 2.25%. Recovery of 13-week Twiggs Momentum above zero also signals an up-trend. Target for the breakout is 2.65%*. This is a bearish sign for bonds, but only breakout above long-term resistance at 3.00% would signal that the secular bull market is over.

10-Year Treasury Yields

* Target calculation: 2.25 + ( 2.25 – 1.85 ) = 2.65

The Dollar Index found support at 94 in response to rising yields. 13-Week Twiggs Momentum is declining, but recovery above 96 would suggest that the correction is over and another test of 100 likely. Otherwise, expect strong support at the primary trendline around 92.

Dollar Index

Gold

Gold is testing medium-term support at $1180/ounce. Breach would test the primary level at $1140. 13-Week Twiggs Momentum holding below zero suggests continuation of the primary down-trend. Failure of $1140 would test the long-term target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000