The Lightweight in the Currency Ring

The Fed’s magic printing power leads many novice investors to a common misnomer: that the U.S. dollar will become worthless as money supply greatly expands.

What isn’t factored into this analysis is, “But what are other country’s central banks doing!?”

Of course, we know, they’re also printing money. We mentioned the relative nature of currency values yesterday with an example: “[Japan’s $145 per month stimulus] is more than 3.5 times the amount we’re pumping in and Japan’s economy is only one-third the size of ours.

Think of currency values as a see-saw… on one side you have the U.S. dollar and on the other side the Japanese yen (or euro, or whatever).

If the see-saw tips out of balance, say the left side rises and the right side drops lower, it can be for one of three possible reasons:

1) The left side becomes “lighter” (this is the side that rises)…

2) The right side becomes “heavier” (this is the side that drops lower), or

3) Both #1 and #2

That’s why analysis of currency values can be tricky. If the USD/JPY exchange rate is going higher… how do you know for sure if it’s because of “dollar strength” or “yen weakness?”

To answer the question, “Which currency is really driving the trend?” you often have to look at three or four related pairings. Let’s take a look…

See larger image

Here are four charts, which I’ll pair up in different ways to determine which currency is “driving” the changes in exchange rates…

Pairing #1 (USD/JPY and EUR/USD): These charts show both dollar strength (USD/JPY) and dollar weakness (EUR/USD). That may seem confusing but it leads me to think that the U.S. dollar is NOT the driver of these trends.

Pairing #2 (USD/JPY and EUR/JPY): These charts both show the possibility of yen weakness. This agreement suggests the yen is weak when compared to several currencies (both the U.S. dollar and the euro). So this seems to be the driving force behind the current trends in these charts.

Pairing #3 (EUR/USD and EUR/JPY): Like Pairing #2, “euro strength” is the common denominator. So for euro-based pairs, it’s the euro’s strength driving the trend.

And finally, the U.S. Dollar Index chart shows sideways movement. This confirms the idea that the U.S. dollar is NOT the main driver of trends in the currency market right now.

So what’s the “take-home?”

Don’t listen to babble about the Fed destroying the dollar. The currency markets are clearly more focused on the yen (with a negative bias) and the euro (with a positive bias).

Adam O’Dell

Using his perfect blend of technical and fundamental analysis, Adam uncovers investment opportunities that return the maximum profit with minimum risk.