Dollar Outlook Clouded by S&Ps ’Downgrade First, Ask Questions Later’ Mentality

by DailyFX

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The Dow Jones FXCM Dollar Index (ticker: USdollar) has been whipped around a little in the last few sessions in the aftermath of the shocking and historical downgrade of the US by S&P. It is our belief that the S&P, and rating agencies generally, have taken up the ‘downgrade first, ask questions later’ motto after their woeful missteps in the run up to the financial crisis. Rating agencies were lambasted for their inability to foresee the balance sheet problems that bankrupt two Wall St banks and cost ordinary citizens billions of dollars and many jobs. The agencies were also criticized for their cozy relationship with the companies with which they were providing coverage and the apparent ‘revolving door’ between the agency’s and the corporations. The bottom line is that they did a horrific, possibly even criminal, job ahead of the financial crisis and with their backs against the wall have adopted an equally ridiculous stance of throwing downgrades around like they are chump change.

This new stance has largely only been seen and felt in Europe with multiple downgrades hitting heavily indebted nations like Greece, Ireland, Portugal and Spain. This action has drawn the ire of the ECB and EU officials alike as they believe, like the author, that the rating agencies have adopted an overly ruthless approach. Now that the US has been drawn into this mess criticism of the ratings agencies is likely to rise above the clamour of various European officials and could trigger a breaking up of the monopoly the three major rating agencies have on the industry. The new ‘downgrade first, ask question later’ outlook was compounded on Friday evening by the massively embarrassing $2 trillion accounting error found by US Treasury officials ahead of the downgrade (it is policy to inform the relevant government ahead of time of a downgrade). While S&P vocally and virulently defends itself and its ultimate decision to downgrade the US’ rating, in spite of the accounting error, for the average commentator the action stinks like something rotten and leaves us with the feeling the S&P were out for their pound of flesh rather than doing their job to the highest possible standard.

In any event, the downgrade stands, rightly or wrongly, and now we must come to terms with its implications for the dollar index. It is our belief that during the coming days of what is likely to be choppy trade, initially, the upper and lower ranges will keep trade range bound. We see rival trends competing for direction; on the one hand a rush for safety in the most liquid and traded currency on the other a divesting of US dollars by institutional investors in favour of those with a ‘AAA’ rating. In coming days we think that neither will be able to dominate and trade will remain loosely range bound.

On the technical side, however, that is a more compelling argument that trade should go only one way; up. Having now confirmed not only a double-bottom but also a bullish outside week last week all signals point north. The index formed a similar pattern while forming the first bottom, posting a bullish outside week and then a second week of healthy gains which topped out near the 9700 level. Since the second bullish outside week was, well, more bullish and we already considerably closer to the 9700 level, technically, the index should climb through this level with ease and test range highs by 9770.

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