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Lately, I’ve been talking about the dollar’s decline...and so far, I’ve been right. However, the last few days in the market has gotten some traders to question their positions and its even scared others out of their positions. Not me! Here’s why...

Nothing has changed in the fundamental picture to warrant a true “dollar rally” that would change the dollar’s downtrend back into an uptrend. Trends in currencies don’t change often, and that’s because the fundamentals behind those economies don’t change directions often.

So if a “true” technical trendchange were to take place on the charts, it would be because there is an actual “fundamental stimulus” that is taking place. Yet, I don’t see anything like that on the horizon...therefore, I know that any rally upward, is simply what I call a “sucker’s rally”.

That’s a rally that traders jump into because they think a trend change is coming. Yet the trend is still downward and will remain downward due to the fundamentals.

Let’s take a look at the fundamentals for a moment and I’ll show you what I mean.

Why Money Flows to a Currency!

Money generally flows into a currency because it’s “chasing yield”, meaning that they want to place their money where it can get the most interest. However, interest rates are only high or headed higher when high inflation exists. When that happens, central banks have to raise interest rates to combat the rising inflation.

So we should look to see how the inflation numbers look in order to get a sense of where investors will be putting their money.

For instance, look at the “year over year” numbers in the Consumer Price Index (CPI) below. You will see them ranked from highest to lowest.

U.S. & Japan are "deep in deflation" right now!

You will notice that the “high inflation” places of the world are places like New Zealand, the U.K. and Australia. Now the U.K. has been printing money way too much, and so that has delayed the effects of the currency gains in the pound so far.

Here's why the Fed won't be raising interest rates anytime soon!

However, New Zealand and Australia have both responded fairly well lately and its due to these inflation numbers.

Now look at who is at the bottom of the list: Japan and the U.S. In fact, their inflation numbers are actually negative which means that its “negative inflation” or also known as deflation.

Now, if an economy is in deflation, is there a need to raise interest rates? NO! Why? Because there’s no inflation to fight. In fact, a bigger enemy than inflation exists...and that’s deflation.

Therefore, you can count on it being quite some time before the U.S. or Japan raise interest rates. Therefore, you can also count on money flowing away from the U.S. and Japan, generally speaking. Where will it go? To the inflationary areas of the world that will have to hike interest rates earlier and keep those rates high for a prolonged period of time in order to tame inflation so that it doesn’t get out of hand.

Since the U.K.’s interest rate is small and they are still in “printing money mode”, much of the money has found its way to Australia which has the highest interest rate of all of the industrialized countries, only to be followed by New Zealand.

This is why I believe that the dollar’s recent rally is simply a bear market rally...a sucker’s rally. You see, even bear markets have upward corrections just as any uptrend has pull backs. Everyone expects pull backs within any uptrend...but they’re shocked when a bear market rallies. I’m not!

And this is just one more bear market rally for the dollar. Therefore use these times to buy the pull backs of the inflationary currencies while shorting the deflationary currencies. This would mean buying currency pairs like AUD/USD, AUD/JPY, NZD/USD and NZD/JPY. These are the ultimate inflation vs. deflation plays right now. It doesn’t mean they will go up every day, because they won’t. But it does mean that they are the ones most likely to hold their uptrends.

The only thing that would likely reverse this scenario would be a “double dip” recession. I don’t see those cards in the deck just yet. So I’ll stick to my inflation vs. deflation play.

Now, looking to the technical side of things...the dollar remains in a downtrend as noted by the red downtrend line and its declining 50 Day Simple Moving Average. The Slow Stochastics are just about overbought in the downtrend and the MACD still has its lines below the “zero line”. These are all bearish implications which happen to also match the fundamental outlook. That comes as no shock because its the fundamentals that produce technical trends. 

U.S. Dollar Index Downtrend Likely to Continue on Weak Fundamentals!

Note: This is my opinion and you should do your own analysis to see if it confirms my findings.

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Sean Hyman

Contributing Writer

http://www.mywealth.com