Long term outlook for forex & commodities


*I do not trade currencies or commodities. I only watch these markets. Read more about my trading/investing.
These are my discretionary thoughts on the U.S. Dollar’s and oil’s long term direction. The USD’s and oil’s fundamentals decide their respective long term directions.
*Oil represents the commodities family.

The U.S. dollar will be range-bound in 2018

The USD’s fundamentals are simple: it’s about money flow. When massive amounts of money flow from the U.S. to other countries, the USD goes down. When massive amounts of money flow from other countries to the U.S., the USD goes up. There are many factors that impact money flow, such as …

  1. Differences in economic growth.
  2. Differences in business opportunities.
  3. Interest rate differentials.
  4. Capital flight/repatriation (e.g. tax cuts).
  5. Massive political risks in major parts of the world (i.e. EU, China)

*The Euro accounts for 57% of the USD Index.
Currency traders tend to overestimate the importance of interest rate differentials and underestimate the first 2 money flow factors. Here’s where these 4 factors stand today:

  1. U.S. economic growth has been relatively stable over the past 7 years. Meanwhile, the European and Chinese economies sank from 2011-2015, bottomed in 2016, and have recovered rapidly. As long as their economies continue to recover, China’s and Europe’s economic growth will be stronger than that of the U.S. This money flow factor is long term bearish for the USD.
  2. Connected to economic growth are business opportunities. With Europe and China on the rebound, businesses are once against investing in these and other emerging markets. This is a long term bearish factor for the USD.
  3. Interest rate differentials clearly favor the U.S. The U.S. is still on a rate hike path, whereas Europe is stuck with QE. Theoretically, this money flow factor should be bullish for the USD. However, rate hikes have not benefited the USD at all over the past 2 years. The Fed first hiked rates on December 16, 2015. The USD has gone nowhere since then.
  4. With the Republican tax cut being pushed through Congress, some argue that this will be a huge bullish factor for the USD. I agree that this is bullish, but I don’t think it’s an important factor. Most U.S. companies hold USD offshore. When they bring that money back to the U.S., all they’re doing is transferring USD from one country (foreign country) to another (U.S.). Cash repatriation is only bullish if these companies exchange foreign currency for USD when bring that money back to the U.S.. More importantly, the USD’s price action with regards to the tax cut isn’t very bullish. The House of Representatives passed the tax bill on November 16. The USD has gone nowhere since then.
  5. The main Euro political risk is Merkel’s election. After sinking for most of 2017, the USD started to bounce (and the Euro fell) on September 24. This risk will last a few more months (Merkel is taking her sweet time to form a coalition, but she is on the right track).

Due to these counteracting money flow forces, I think the USD will continue to be range bound in 2018 (between 100 and 90). This is a swing traders market.

Oil

WTI oil has a bottom line at $50. The massive crash in oil prices from 2014-2016 was caused by U.S. shale. Whereas countries like Saudi Arabia need $75 oil to breakeven, U.S. producers need $50 to breakeven today. With WTI solidly above $50, why aren’t U.S. producers pumping more, increasing rig counts, and pushing the price down to $50?

  1. Oil isn’t far above $50 right now. It’s hovering just under $60. U.S. producers don’t want to ramp up production only for oil to fall below $50 again.
  2. Oil company shareholders have pressured management for higher profit margins. These shareholders would rather see higher profit margins on lower volume (e.g. pump less crude at $58) than lower profit margins on higher volume (e.g. pump more crude at $52).
  3. U.S. producers have made it clear that they’ll significantly ramp up production and rig counts if oil rises above $60 for an extended period of time.
  4. U.S. oil servicing costs are rising slowly but steadily. As production costs exceed $50, the bottom price for oil will rise slowly.

I think that oil will not significantly exceed $60 in the next few months. Instead, oil’s range will slowly rise from $50-$60 as production costs rise in the U.S.

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