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The Dollar Index (DXY) broke out of a long-term trading range and started moving up sharply in mid-2014 until it broke a long-term trend line at 95 in December 2014. It has spent most of the subsequent period trading above this key level, signaling that it could trade much higher in the coming months.
Keep an eye on the DXY. As of Q4 2016, it’s above 97 and likely to move higher, which would have massive deflationary consequences for global markets.
While the Fed ended quantitative easing and began raising interest rates at the end of 2015, the ECB and the Bank of Japan are moving in the opposite direction, initiating huge new bond-buying programs to lower interest rates in their markets. That means Europe and Japan are dead set on cheapening their currencies against the dollar. As a result, the U.S. dollar will keep rising as global investors flee lower-yielding currencies and flock to the higher-yielding U.S. currency. That should push the dollar upward and further depress the euro and yen.
You can buy ProShares DB US Dollar Bullish ETF (NYSE Arca: UUP), which closely tracks the exposures in the DXY. This ETF rises when the dollar rises.
These Currencies Are Set to Fall
As surely as gold and the dollar will rise, these major currency players are going to fall. As always, unless otherwise noted, puts are my preferred way to make short-side profits – they allow you to tightly manage your risk exposure.
Currency Short Recommendation No. 1: The Euro
In mid‐2014, the euro (as well as the yen and other currencies) began to fall against the dollar as U.S. monetary policy began to diverge from those of other major central banks in Europe, Japan, and elsewhere. The Federal Reserve ended quantitative easing in October 2014. In contrast, the Bank of Japan and European Central Bank were about to double down on their versions of this doomed‐to‐fail policy, which they did in October 2014 and January 2015, respectively. They’ve continued these efforts in 2016 and are likely to do so for the near future.
That means the euro is likely to continue falling against the dollar.
You can sell short the euro by buying ProShares Short Euro ETF (NYSE Arca:EUFX). This ETF rises when the euro falls.
Currency Short Recommendation No. 2: Chinese Yuan
Right now, China is facing serious pressure to devalue the yuan. China’s economy hit a wall in mid-2014 and since then, more than $1 trillion of capital has left the country. The country’s $4 trillion of foreign exchange reserves has dropped to nearly $3.3 trillion as the authorities have spent hundreds of billions of dollars defending the currency. Of its remaining reserves, only about half are liquid, so it can’t continue to spend money at the rate it has to keep defending the yuan.
China is either going to have to impose stricter capital controls to keep money from leaving or stop spending its reserves to defend the yuan. If it imposes capital controls, wealthy people in China will get even more nervous about their continuing ability to move their money out of the country – and redouble their efforts to do so. Such a move would also be a blow to the Chinese view of itself as a global economic leader; but it may not have a choice. Either way, the yuan could move much lower than people expect.
The yuan is undoubtedly overvalued and will decline in value over time, but as tempting as it is to imagine a Chinese collapse, it simply isn’t going to happen quickly.
This is an interesting opportunity. There’s no easy way for Americans to short the yuan, but you can quite easily make money from the knock-on effects of its decline.
First, investors can short all emerging markets by short-selling the iShares MSCI Emerging Markets ETF (NYSE Arca: EEM).
Second, they can short the Chinese stock market by shorting the iShares China Large-Cap ETF (NYSE Arca: FXI), which has traded between $52.85 and $28.81 over the last year and is currently at $30.20.
They can also short the iShares MSCI Singapore ETF (NYSE Arca: EWS).
Short Recommendation No. 3: The Japanese Yen
Japan’s government has no choice but to continue to weaken the yen in order to deal with the country’s terminal debt and demographic challenges. A cheaper yen will boost Japan’s export businesses.
In addition, Japan’s corporations have become very competitive globally as a result of having to operate with an expensive currency for so many years.
As a result, they are poised to generate strong profits if they can sell more of their goods under a weak-currency regime. The yen is likely to decline more rapidly than the yuan despite the yen’s recent strength (and clearly that isn’t a speedy trade in itself).
The yen has been a big disappointment to those (myself included) expecting it to drop against the dollar this year as a result of Japan’s increasingly desperate efforts to weaken its currency and stimulate economic growth. Despite unprecedented efforts to ease monetary policy, the yen surged to an 18-month high by mid-April against the U.S. dollar.
Not to be deterred, the Bank of Japan said it “will not hesitate to take additional easing measures in terms of… quantity, quality, and the interest rate if it is judged necessary.”
I would maintain short yen positions, however, because the Japanese will continue their efforts to debauch their way out of insolvency. Their efforts won’t work, but they won’t stop trying.
Here’s what you can do about it.
Buy long-dated puts on CurrencyShares Japanese Yen Trust ETF (NYSE Arca:FXY).
Short the Japanese stock market by buying puts on iShares MSCI Japan ETF (NYSE Arca: EWJ).
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