Here’s What the Direction of the USD Will Tell Us…

Keep an eye on the US dollar this week. Its action will tell us the likely direction for long-term interest rates after the Fed starts cutting short-term rates next week.

You see, there are conflicting arguments about the benefits of cutting short-term rates. Some folks believe if the Fed cuts the target for the short-term Fed Funds rate – a rate over which it has direct control – long-term rates will follow suit and come down as well.

A growing number of folks, including yours truly, argue that absent a Quantitative Easing program – where the Treasury prints money and gives it to the Fed to perform open-market operations – lowering the Fed Funds rate will cause long-term rates, over which the Fed has no direct control, to rise.

We’ll know the immediate effect for sure next Wednesday if the Fed cuts its target rate as expected.

Between now and then, though, we can get a clue to the direction by watching the dollar…

Many factors affect the value of the dollar versus other currencies. But, the dominant factor is investors’ expectations for long-term interest rates.

In the currency market, money flows to where it is treated best. If currency traders expect higher long-term interest rates, they’ll buy dollars and the US Dollar Index (USD) will rise.

If traders expect long-term rates to fall, they’ll sell dollars, and USD will decline.

Here’s an updated chart of the index…

The buck hasn’t done much of anything since we last looked at it. But, you can see how all of the various moving averages have coiled together. The chart is building energy and preparing for a big move in one direction or the other.

The chart also appears to be forming a large consolidating triangle pattern – which also tends to precede a large move.

And, USD is approaching the apex of the triangle. So, a breakout should happen soon – likely just before next week’s FOMC decision.

My guess is the dollar is setting up for a breakout to the upside – which will forewarn of higher long-term interest rates. But, I’ll respect a move in the opposite direction if the dollar moves lower.

Traders who are betting on a larger move in long-term rates should pay close attention to the above chart. Rates will break in the direction of the buck.

Best regards and good trading,

Jeff Clark
Editor, Market Minute