2018: The Pivot Year

Coming into 2017, I expected USDCNY would dip to around 6.60 and then resume its rise. Instead, it got as low as 6.48 and closed the year at 6.51. Overall, this remains a dollar story, but there's two possible paths for the greenback.

I still lean towards a finally rally in the U.S. dollar as the next economic crisis/global recession comes into focus. The dollar is above the long-term resistance line.

However, the analog to prior bull market advance is in limbo. I think a compelling case can be made for a dollar top being in:

There are two potential analogs then. We could be at June 2002 and already past the first drop in the greenback. Or we're still somewhere in 1999, consolidating before the next advance.

I lean towards one more surge in the dollar during the next recession as dollar credits default or are repaid. There's no sign yet of credit growth, indicators such as consumer confidence and unemployment are coincident with the peak of an economic expansion, not the middle. Things could get much better considering growth was below trend for a decade, but there's little sign yet of a breakout.

Politically, Trump was unable to push his agenda because the Russia-collusion story derailed his administration for the first six months or so. This delayed action on trade reform/tariffs. I expected these actions to spark instability in financial markets. Instead, volatility went to new lows. It looks like the Russia-collusion narrative is doing a rope-a-dope now. If this dossier was the main piece of evidence for FISA warrants, this is already a bigger scandal than Watergate. Not only will the investigation go away for Trump, but he could have several high ranking Democrats under investigation by a special counsel in addition to having a free hand to clear the decks at Justice and the FBI. At worst, Trump's political capital recovers (he loses the weight of the investigation). At best, his enemies are under severe threat of prosecution or the stink of using the defense-intelligence apparatus to spy on a domestic political opponent.

On the other side, Chinese growth is slowing and they recently eliminated tariffs on steel exports. Tensions in North Korea aren't improving U.S.-China relations. One way or another, I expect action on trade in 2018.

Finally, the overall trend in social mood remains negative. I believe this is a higher order decline as in the 1930s, and thus dollar positive (deflation) rather than a correction and inflationary (1970s).

As I said above, I could be wrong. And the best case for my being wrong is still the commodities markets. Several funds such as steel, copper and coal (and related emerging market countries reliant on natural resource exports) are on the verge of breakouts. I expect China to slow, but FXI recently broke out above its resistance again and opened up 3 percent on Tuesday.

Smaller commodity ETFs such as rare earths (REMX) and Lithium (LIT) have the strongest momentum in the market now, along with crude oil (BNO, DBO). I remain bullish on the USD, but hedged with high volatility commodity plays.