One Chart to Rule Them All

I've seen more than one macro economist say the U.S. dollar will plunge next year. There are lots of theories about why the dollar will decline. The latest comes from Stephen Roach.

ZH: Yale Economist Warns Of Looming Dollar Collapse

The first bit is from dollar permabear Peter Schiff:

With the federal budget deficit exploding towards 16% of gross domestic product this financial year, according to the Congressional Budget Office, the savings plunge is only a hint of what lies ahead. This will trigger a collapse in the US current-account deficit. Lacking savings and wanting to invest and grow, the US must import surplus savings and run massive external deficits to attract foreign capital.”

Basically the same thesis that every dollar bear has peddled for the past 40 years. Here's the thing about cyclical markets though: broken clocks get to be right once in a awhile. In this case, about about once every 18 years.

Back in 1985 and in 2002, the U.S. dollar began precipitious declines that lasted for 2 to 3 years. In both cases, the DXY fell through its 6-year moving average like a hot knife through butter and kept on falling with little to no countertrend rallies.

How much does Stephen Roach say the U.S. dollar will fall? 35 percent. Or almost the exactly same target you would get from looking at the DXY chart for a few minutes. Where's my Yale PhD?

Below I highlight the measured moves in the DXY after it broke through its 6-year moving average. The final two charts show possible targets for DXY nexy year assuming similar declines and Roach's forecast.

Unless Roach is claiming the dollar will break long-term support next year, he's predicting it will proceed within its 40-year cycle. I believe a dollar bear market is possible because it is time based on the prior two cycles. Additionally, this would be a healthy decline for the U.S. dollar and the global economy. It would not threaten the U.S. dollar. Break support and then we can talk about dollar doom.

A bear market isn't guaranteed though, at least not yet. Right now the U.S. Dollar Index is testing its breakdown. Neither the 1985 nor 2002 bear markets looked back after slicing though their 6-year moving average. A reversal this time would catch many traders off guard and open the possibility of the dollar breaking above its long-term resistance again. It would be historically significant, albeit within a sample set of three.

The important area is the blue horizontal at 95.95, call it 96. Below this line, the dollar bear scenario is in play. Below 88 on the DXY and I would throw nearly all caution to the wind in forecasting a bear market. Above 96 and we might soon be saying "Goodnight Gracie" to the dollar bear forecasts.