What drives the DXY and Fed Funds relationship is not only a severely overbought Fed Funds rate but the correlation at the 1 year monthly average is negative 35% and positive 34% at the 2 year. Correlations taken to 10 year monthly averages reveal only the 3, 4 and 5 year are barely positive above + 50% while remainder averages are below 50%. Not only is the DXY V Fed Funds rate completely disconnected but the best the relationship can achieve is + 65% to + 74% on the high side and minus 0.19 to 26 on the low side. Overbought Fed Funds is driving the misaligned Correlations.
At Fed Funds 0.40 and the most popular close price since June 23rd, the correlational dilemma is seen in the DXY Vs Fed Funds relationship as Fed Funds from the trend line is negative Vs DXY at the 1 year then turns positive from the 2 to 10 year. Despite positive, Fed Funds is miles above the trend line at 0.40 and should trade easily from 0.15 to 0.20 especially at DXY’s close today at 94.77. The problem with 0.15 to 0.20 is the range is held from 0.25 to 0.50 and maturing FED bonds held on the balance sheet reinvested between 0.20 to 0.25.
What is actual in Fed Funds is seen in the DXY V Fed Funds relationship as the top of the trend line is located from 0.23 to 0.28 with must breaks from 0.16 to 0.19 to see 0.14 to 0.05.
If Fed Funds is viewed by itself then targets range from 0.39 and 0.36 to 0.23 and 0.22. Why Fed Funds is miles overbought viewed either by itself or Vs DXY is because the averages from 1 to 10 years are located from 0.14 to 0.19. Since December 16, Fed Funds closed from 0.37 to current 0.40. Despite a higher Fed Funds, the averages lack ability to follow higher. Reported is averages from 1 to 10 years but a longer term perspective from 15 to 20 years, Fed Funds remains far more misaligned V DXY. In 2005, Fed funds traded at 5.25 and 5.0 and 6.0 in year 2000. Fed Funds trades at its lowest rate since August 1954.
What Fed Funds reveals in DXY from today’s 94.77 close, bottoms are located from 89.36 and 91.47 to 92.94 and 93.94 highs. From monthly averages, DXY trades between 1 and 2 year averages at 96.78 to 94.58. DXY has been on a slow decline since December 2015 and its due to the higher Fed Funds rate and negative Correlations.
Overall, average lines V Fed Funds are located from 96.00’s to 98.00’s then the flood gates open on breaks to target 102’s to 105’s.
Whle the market awaits Yellen, DXY is not only low but oversold and far below trend lines. If Yellen raises, DXY goes lower and higher if she backs off the raise. Yellen’s indecision or lack of clarity by mixed messages factors into the RBNZ, RBA and BOE moves to lower overnight rates and lower into an existing oversold condition.
Brian Twomey, Inside the Currency Market, btwomey.com