The Center of the Financial Universe: The US Dollar

The movement of the past few days prompted me to do a deep dive on the US Dollar—a renewed interest in the “big picture”—where the dollar is going longer term. In this case the technicals tell a much different picture than the prognostications of many of the pundits, which are muddying the minds of investors and anyone else with a question as to what the future holds (in terms of deflation vs. inflation).

From a fundamentals perspective, to anyone who knows anything about our ponzi-scheme of a banking system, it should be clear that spiralling deflation is on the horizon. After all, credit is already starting to freeze up internationally, once mortgages start to go bad in the thousands (and digital money starts to disappear, along with a lot of the banks pushing digital currency), plus the eventual reckoning with the extreme amount of corporate debt out there (thanks, share buy-backs!), then all deflationary hell is going to break loose.

But, what do the technicals say?

Let’s look first at the relationship between the US indices and the US Dollar. To do that, it’s important to look at the major turns of both assets.

Above is the two hour chart of NYSE (New York Stock Exchange), the largest exchange in the world, by market cap. Notice the turn on January 29, 2018. This was the top of the third wave of a corrective wave up from 2009. The subsequent drop sent us into a fourth wave contracting triangle.

Contracting triangles (in fact, any triangle) in the fourth wave position announce the end of a trend. They’re the penultimate wave, or pattern, before the trend change. To that end, once the E wave of the triangle is complete, there will be one more wave up in five subwaves to a new high to end the trend. The market will then turn and head in the opposite direction: That direction is down … a long way down.

Above is the daily chart of UUP. The Invesco DB US Dollar Index Bullish ETF provides inverse exposure to an index of USDX futures contracts that rises in value as the dollar appreciates relative to a basket of world currencies. In other words, it parallels the movement of the US Dollar Index, which I show below.

The importance of this chart (which parallels the movement of the dollar) is due to the fact that it shows a reversal at 23.09 on January 26, 2018, virtually the same date as the NYSE (and related US indices) turned south. The entire contracting triangle that’s played out in the NYSE chart has done so while UUP has rallied to the 25.10 area in a corrective wave. It’s now ready to turn back down to a new chart low (to at least the 23.00 area). I’d give it another couple of weeks to complete the turn.

The turn is setting up to happen just as the NYSE is set to finish the E leg of its contracting triangle. That will lead to a rally up into the final wave of the trend (as I mentioned above)—a final fifth wave.

The point here is that (as I’ve been projecting would happen for the past two years plus), the US dollar is inversely aligned with the US equities market. With one more wave down projected for UUP, we have one final wave up to go for the US equities.

Once the US equities turn at the top of that fifth and final wave, the US Dollar will turn and head up. That’s deflationary. The reserve currency increasing in value is the definition of delation in the financial environment in which we live today.

Now, let’s take a look at the US Dollar index on a longer-term basis.

Above is the monthly chart of the US Dollar Index. This is not the raw dollar data, but is the index that’s most widely followed. It’s actually a basket of currencies.

The US Dollar index is explained in Wikipedia as a weighted geometric mean of the dollar’s value relative to following select currencies:

• Euro (EUR), 57.6% weight
• Japanese yen (JPY) 13.6% weight
• Pound sterling (GBP), 11.9% weight
• Canadian dollar (CAD), 9.1% weight
• Swedish krona (SEK), 4.2% weight
• Swiss franc (CHF) 3.6% weight

Nonetheless, it conforms to the Elliott Wave rules, as does any market.

There are several take-aways from the above chart:

• Going back to 2008, you can see that the dollar bottomed as the US market topped (remember the start of the “Great Recession?” Well, this chart tells us is isn’t over). The US Dollar rallied in 2008 into the beginning of 2009 (wave red circle A), when the US indices turned up (as quantitative easing began). The rise was deflationary (the dollar increasing in value); the subsequent reversal was inflationary (red circle B), but it didn’t last. The dollar eventually turned back up, which is deflationary. The Fed has tried to re-inflate, but has been unable to (deflation now has the upper hand).
• From an Elliott Wave standpoint, I’ve labelled this entire sequence to the upside (starting in 2008) as corrective. The reason for this is that although both the red circle A wave and red circle C wave are in five waves, those waves aren’t impulsive. There are three key reasons why:
  • The red circle A wave does not have the “right look.” The subwaves don’t adhere to EW rules for impulsive waves.
  • Wave blue circle 5 of the red circle C wave is in 3 waves and it not the correct length for a fifth wave (not even close).
  • The most recent wave down (marked with small black “a” label) could be considered to be a fourth wave of a larger impulsive sequence BUT it’s clearly in the area of what would be the first wave of the larger sequence (which I’ve labelled as the red circle A wave). That’s basic EW rule and makes the entire sequence “corrective.”

This last sub-point is important, because this means that the entire sequence rallying to new highs will at some point reverse. However, I believe that will be after another series of 5 waves to the upside (at least). This conclusion is debatable, based on the above chart, because there are those that will argue that we currently have a zigzag in place (a corrective pattern) and that it will reverse now, and result in a new low.

So, the bottom line is that the long-term direction is debatable, based upon the Dollar Index alone. But I never just look at one chart …

Above is the 8 day chart of UUP. This represents a similar timeframe to the long term US Dollar Index chart above. However, it’s slightly different.

The chart shows five waves up from the bottom in early 2011 (it did not have a lower low in 2008). While the US Dollar Index chart is inconclusive (from a technical perspective, it can be argued that is could go either way longer-term), the chart of UUP is conclusive.

What you see here is 5 waves up in what I’m labelling a blue circle A wave. I’ve done that because this set of 5 waves up is not impulsive (not a long-term trending pattern). I’ve put asterisks at the points where the subwaves are in three waves.

Elliott wave rules tell us we never just have one set of five waves (it doesn’t matter if it’s  an impulsive or corrective environment). In a corrective environment, which this appears to be, the least you can have is a zigzag (a set of 5 waves, followed by a three wave reversal, followed by another set of 5 waves in the same direction as the first 5). The conclusion I have to draw from this UUP chart is that, after this downward correction is complete in the US Dollar, we’ll have another set of five waves up to a new high, which is deflationary.

Short term: The yellow B wave on the chart above is in three wave and must retrace to the downside. Backing up that conclusion is that the fact that the yellow A wave is in five waves. As I’ve said above, a five waver always means there’s another wave to come in the same direction as the original five waver. This wave may bottom at the A wave low, or it may go lower. In the case of UUP, as there are clearly five waves to the upside, and the A wave has reached the 62% retrace level, I suspect the C wave may just test that level and turn back up. However, I can’t be sure of that.

What I can be sure of is that it will happen at the same time as the US indices finish the fifth and final wave up to a new high. Remember, that several of the US indices have traced ending diagonals (the Nasdaq and the Russells) and this puts a cap of the US market. The fifth wave of the ending diagonal cannot be longer than the third wave.

Bonds

TNX, ten year treasury bonds (as well as TLT, the twenty year fund) appear to be reversing, which I warned about close to two months ago, or longer. What that means is that money is starting to flow into the US Treasury (a safe haven in times of major trouble) and that interest rates in the US are not going to increase. The Federal Reserve does not control interest rates (I’ve written about this before), they simply follow the market, something they don’t make very well known … (wouldn’t want anyone to think they’re not in total control … lol).

Conclusion

Based upon this work, from a technical perspective, the US Dollar is going to turn and head up (deflationary), as the US equities market tops.

Interest rates are going to stay low and money starts to find its way to the perceived safest haven—the US Treasury.

While we’ll move into escalating deflation (as we have in every cyclical financial collapse in history), at some point, that will reverse, by whatever means. Of course, we have a lot of economic parts moving here, with the reserve currency clearly being challenged around the globe. While I think the overall path is clear, it’s certainly going to be interesting to see how it all plays out in reality.

That’s it for now. I’m sure I’ll have more to say on this subject as the we open additional chapters in our political and economic novel, which is becoming exceedingly seedy.

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Elliott Wave Basics

There are two types of Elliott wave patterns:

• Motive (or impulsive waves) which are “trend” waves.
• Corrective waves, which are “counter trend” waves.

Motive waves contain five distinct waves that move the market forward in a trend. Counter trend waves are in 3 waves and simply correct the trend.

All these patterns move at what we call multiple degrees of trend (in other words, the market is fractal, meaning there are smaller series of waves that move in the same patterns within the larger patterns). The keys to analyzing Elliott waves is being able to recognize the patterns and the “degree” of trend (or countertrend) that you’re working within.

Impulsive (motive) waves move in very distinct and reliable patterns of five waves. Subwaves of motive waves measure out to specific lengths (fibonacci ratios) very accurately. Motive waves are the easiest waves to trade. You find them in a trending market.

Waves 1, 3, and 5 of a motive wave pattern each contain 5 impulsive subwaves. Waves 2 and 4 are countertrend waves and move in 3 waves.

Countertrend waves move in 3 waves and always retrace to their start eventually. Counrtertrend (corrective waves) are typically in patterns — for example, a triangle, flat, or zigzag. Waves within those patterns can be difficult to predict, but the patterns themselves are very predictable.

Fibonacci ratios run all through the market. They determine the lengths of waves and provide entry and exit points. These measurements are really accurate in trending markets, but more difficult to identify in corrective markets (we’ve been in a corrective market in all the asset classes I cover since 2009).

To use Elliott wave analysis accurately, you must be able to recognize the difference between a trend wave (motive) and a countertrend wave (corrective). There’s very much more to proper Elliott wave analysis, but this gives you the basics.

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The Market This Week

Here's the latest daily chart of ES (emini futures)

Above is the daily chart of ES (click to enlarge, as with any of my charts).

This past week, I was expecting a rise into the B wave of this large contracting triangle. My target was 2750, due to the displayed weakness of a large bearish triangle that didn't make  a lot of sense to me. That's because it had set itself up in the middle of the E leg of our triangle.

However, in a combination wave, which we have (typical in a triangle leg), if a triangle appears as one of the combination patterns, it is always the last one. In this case, that would have meant a fifth wave (out of the bottom of the triangle) down over 100 points, which didn't seem possible (without creating yet another pattern, which isn't possible). As a result, I expected the triangle to be negated. It was.

The 2750 level was pierced and exceeded (markets can wander around the interior of a triangle as they please—rules are few) and now we have an extended rally which reached the 2765 area on Friday. It has another leg up still to go—a  fifth wave up of a five-waver.

Keep in mind, though, that the entire sequence up is highly corrective (it has an entire corrective triangle—a bearish one!—below it, so we're not going to a new high, nor is this anything but a B wave of the E leg of a contracting triangle.

One of the reasons for my concentration on the US dollar this week is that fact that I consider it the instigator of this rise. The US Dollar is attempting to top in it's B wave (that's almost always a volatile process). Its volatility is pushing the B wave in the US indices to extremes.

The good news is that its setting up a very much larger drop in the C wave of the E leg. So while it demands more patience in waiting for the turn, the payoff will be that much larger.

Watch for a top in the first part of this week (it may take a couple of days to complete this rally).

Summary: We continue to trace out the E leg of a contracting triangle. Once the E leg (down) is complete, expect a final fifth wave to a new high. That fifth wave up to a new high will be the end of the 500 year bull market.

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