Eight Months into Quantitative Tightening: Where Are We Now?

It has been eight months since the Federal Reserve began its balance sheet reduction program, affectionately adapted as "quantitative tightening (QT)" by Wall Street, the opposite of the "quantitative easing (QE)" program the Fed used to purchase securities after the 2007-2009 recession.

The pace of this balance sheet 'normalization' program was outlined in the Federal Open Market Committee's June 2017 policy meeting as an addendum, and was outlined as below:

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

So, for Treasuries, the Federal Reserve began "rolling off" $6 billion worth of securities each month in 2017 Q4, and then $12 billion of securities each month in 2018 Q1, now at an estimated $18 billion per month in 2018 Q2. In July, that pace will again accelerate to $24 billion per month for the third quarter. For mortgage-backed securities (MBS) and agency debt, the initial pace in 2017 Q4 was $4 billion per month, then $8 billion per month in 2018 Q1, followed by $12 billion per month now in 2018 Q2. Similarly, this will increase again to $16 billion per month in 2018 Q3.

Adding it all up, the second quarter of 2018 is seeing the Federal Reserve "roll off" $30 billion in securities per month, for a cumulative $90 billion in securities released for Q2. When Q3 rolls around in July, the total number of securities coming off the Fed's balance sheet each month will ramp up to $40 billion, for a cumulative $120 billion balance sheet reduction in 2018 Q3.

This process is not an exact science, of course, so these numbers are more reference points than anything. But data from the Federal Reserve shows that this process is already well underway.

Source: St. Louis Federal Reserve FRED

The size of the Federal Reserve's balance sheet has shrunk from $4.46 trillion on October 4, 2017 to $4.32 trillion as of June 6, 2018, for a total reduction of $140 billion. By the math and FOMC guidelines above, through May 2018, roughly $150 billion in securities should have already been subtracted from the balance sheet. In the broad scheme of things, this discrepancy is pretty minor, and the key takeaway is that the Fed is proceeding with its balance sheet normalization program pretty much as advertised.

One of the main worries about quantitative tightening is that this increased rush of Treasury debt supply would ratchet up U.S. bond yields, thereby tightening domestic (and, for all intents and purposes, global) financial conditions as interest rates on mortgages and other consumer debts rise as well. Has this worry panned out?

Source: St. Louis Federal Reserve FRED

It is not debatable that U.S. Treasury yields have increased since September/October 2017. The 10-year Treasury note yield (the red line above) has risen from ~2.1% in September 2017 to as high as nearly 3.1% in May 2018. That's an increase of about 100 basis points in just under eight months- a non-trivial increase. However, it is wrong to fully attribute this increase in bond yields to the Fed's balance sheet reduction program, no matter how enticing the above chart makes that conclusion.

First, global growth was seen picking up to end 2017. Indeed, the phrase 'global synchronized growth', or something similar involving the word "synchronized", became quite popular as both advanced economies (AEs) and emerging market economies (EMEs) saw economic output kick into a higher gear. 

Prior to this, the United States was holding the honor of comparatively-strong economic growth; the eurozone continued to shake off scars from both the financial crisis and sovereign debt crisis into the middle of this decade, while China took a hard stumble near the halfway point of the decade. India's sudden demonetization injected uncertainty into the minds of foreign investors, and a less-than-stable banking system continues to stand in the way of more sustained and confident economic growth. 

However, 2017 saw the core of the eurozone - especially Germany - regain its economic mojo, with German real GDP growing at an annual rate of 2.9% in 2017 Q4, the highest mark since 2011 Q3. Worries over the Italian banking system were soothed as the largest trouble spots - Banca Monte dei Paschi di Siena and two regional banks - were cleanly dealt with. Elections in several major EU countries saw populist candidates lose out, much to the cheer of investors. Outside of the EU, China beat expectations with 6.9% annual GDP growth for 2017, African nations continued to see infrastructure investment as part of China's Belt and Road Initiative (BRI), and protectionist fears around the globe, aimed primarily at the U.S., were put off ... until this year, apparently.

The rebound in global economic growth provided a very convenient excuse for investors to diversify their portfolios and pursue investments in the eurozone, Africa, and other regions. The comparative decrease in the attractiveness of U.S. assets was likely a factor in sending U.S. interest rates higher.

Second, the new U.S. spending bill passed at the tail end of 2017 requires a significant uptick in the issuance of U.S. Treasury debt. This is an added supply burden to the increased supply already in place from the Federal Reserve's balance sheet runoff, and it's quite likely both the expectation and reality of increased Treasury debt supply due to the spending bill boosted U.S. bond yields.

Thus, while the Federal Reserve's "quantitative tightening" program is more than likely raising U.S. interest rates (and will likely continue to do so as the program's pace accelerates), there are other factors at play that have helped to keep interest rates elevated.

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So, where are we now? The Federal Reserve Bank of Chicago's Adjusted National Financial Conditions Index (ANFCI, a preferable acronym to that whole mouthful), a good way to see how easy or tight financial conditions are, has indeed increased since November 2017, but remains solidly in negative territory. In the ANFCI, negative values imply easier financial conditions.

Source: St. Louis Federal Reserve FRED

Warranting more attention than the ANFCI is the rise in mortgage rates, which have jumped from 3.90% to start December 2017 and peaked at 4.66% on May 24, 2018- a rise of 76 basis points in about six months, again a non-trivial movement. 

Source: St. Louis Federal Reserve FRED

I believe this rise in mortgage rates will eventually hurt housing, but I could (and probably will eventually) write a whole separate post about the reasons why and why not these higher rates could hurt housing this year. For this post, though, it's likely that the Federal Reserve's "quantitative tightening" program has helped increase mortgage rates, again combined with other factors.

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In general, these effects of higher U.S. bond yields are not yet significant, particularly when compared to yields of over 5% as recently as the eve of the financial crisis. It's plausible that there is some "sticker shock", particularly with respect to the higher mortgage rates, but aside from this the effects of the Federal Reserve's balance sheet runoff have not been debilitating, or even so much as notably inhibiting to the financial system. Indeed, "cov-lite" leveraged loans remain a hot commodity in global financial markets.

For now, "quantitative tightening" is more akin to a few gentle turns of the screwdriver than an electric drill. Perhaps in another eight months, the screws will have tightened even more... or perhaps too much more.

Andrew

Vulnerability in the High Yield and Leveraged Loan Markets

This is a research report I wrote up earlier today on a specific vulnerability that worries me in the riskier areas of fixed income. 

Summary

Over eight years after the end of the Great Recession, the economic recovery that has slowly but surely powered the United States into a 4.1% unemployment rate and sent stock market indexes to dozens of record highs this year has now spread around the globe. With heavy-handed support from leading central banks, financial markets are thriving, with suppressed volatility and generally-positive economic data supporting both advanced and emerging economies. Unconventional monetary policies employed by G20 central banks, particularly the European Central Bank (ECB) and Bank of Japan (BOJ), have led to an asymmetric recovery in certain sectors of global financial markets, however, whether directly or indirectly. In this report, unconventional monetary policies will be connected to the increasing deterioration of covenants in riskier sections of the fixed income market, and concerns over systemic risk posed by such sectors of the fixed income market will be outlined.

            Introduction

In response to the 2007-2008 financial crisis and succeeding deep recession, central banks in advanced economies found that their conventional monetary policy tools were not as effective as desired. Faced with the zero lower bound dilemma, leading central banks asserted themselves into uncharted territory with the use of new monetary policy measures. The most visible and widely-discussed tool at hand was that of quantitative easing (QE), the process by which a central bank purchased their nation’s sovereign debt (for the ECB, up to 33% of each EU member’s sovereign debt), in a bid to stimulate the economy and lower borrowing costs for consumers. Through such QE operations, the G4 central banks (the Federal Reserve, the ECB, the BOJ and the Bank of England) purchased securities that sent their balance sheets to a combined 37.4% of their cumulative GDP.

Figure 1. Source: Bloomberg

            The composition of the balance sheets for each central bank vary, however. For example, the Federal Reserve invested its $4.5 trillion balance sheet primarily in Treasury securities, as well as agency debt and mortgage-backed securities (MBS):

Figure 2. Source: Bloomberg

            In contrast, the European Central Bank has accumulated nearly 33% of each European Union member’s sovereign debt, the threshold of which was set by the Bank and is unlikely to be increased due to German opposition to the continuation of QE. The ECB also undertook significant purchases of corporate bonds, a program which also is still ongoing. The Bank of Japan has employed the most unconventional monetary policy of the G4 banks, and perhaps of the world. Indeed, the BOJ now employs ‘Quantitative and Qualitative Easing’ (QQE) and ‘Yield Curve Control’ (YCC), as well as maintaining a benchmark interest rate of -0.4%. The YCC portion involves the Bank of Japan maintaining the 10-year Japanese government bond yield at a rate of around 0.00%. The Bank had stepped in with offers to buy an unlimited amount of bonds at a rate of 0.11% earlier this year, when the 10-year yield began climbing, in a motion similar to that of a central bank offering to defend its currency peg if necessary. As part of its QQE program, the Bank of Japan now holds significant stakes in the Japanese sovereign debt market, Japanese corporate debt, Japanese stocks and exchange-traded funds (ETFs), all in bids to suppress volatility and encourage consumer spending.

            The successes and failures of these varied monetary easing programs are not for discussion in this report. Rather, we aim to focus in on the Federal Reserve’s quantitative easing operations, and its consequences as reflected on riskier portions of the fixed income market- namely, leveraged loans and the high-yield corporate debt sectors.

            The Federal Reserve’s QE program was designed to decrease borrowing costs for consumers, and the suppressed nature of the 10-year Treasury note yield shows that this has happened.

Figure 3. Source: Bloomberg

            With Treasury yields continuing to plumb record low levels over the last several years due to the Federal Reserve’s QE, investors have been driven to riskier assets in their search for yield. A primary beneficiary of this tactic (a deliberate one, at that) has been the stock market, with the Dow Jones Industrial Average (DJIA), S&P 500 and Nasdaq Composite setting over 100 record closes combined this year. While this is due in large part to investor enthusiasm over the expected agenda of President Donald Trump, stock markets were strong and looking stronger in the months leading up to the 2016 presidential election.

            In a sign of investors’ search for yield, even riskier assets have seen stronger returns than stocks. A prime example of this is the return offered on Bank of America Merrill Lynch’s High Yield corporate bond index.

Figure 4. Source: Federal Reserve Bank of St. Louis – FRED.

            On an indexed basis, where the beginning of the 2007-2009 recession was set to 100, the S&P 500 has seen its value increase by a multiple of 1.8, through the end of October 2017. BAML’s High Yield Total Return Index, however, has seen its value more than double over the same period, appreciating by a multiple of nearly 2.2 through October 2017. It is no secret that investors who favored junk bonds over the last eight years have been handsomely rewarded- even today, the effective yield of BAML’s High Yield corporate bond index still tracks above the 10-year U.S. Treasury note, but that’s where the concern starts.

Figure 5. Source: Federal Reserve Bank of St. Louis – FRED

            The effective yield has hit record lows on multiple occasions since the end of the previous recession, with the most recent nadir in 2014, though even today junk bonds hold a slim premium over Treasuries.

            Let’s recall the purpose of a premium. We first recognize that U.S. Treasuries are the risk-free rate, as the U.S. government will not default on its debt (this has been called into question over the last decade, but for all intents and purposes, we will leave this assumption undisturbed). To hold an asset that is riskier than Treasuries, therefore, leaves investors demanding compensation for retaining that risk. Such compensation comes in the form of a premium, the higher yield compared to Treasuries. Relative to Treasuries, highly-rated investment grade corporate bonds (i.e. AAA-rated or AA-rated) will trade with a small premium to Treasuries, as they are quite unlikely to default. Riskier corporate bonds, such as A-rated bonds, will contain a larger premium with their correspondingly-higher risk, and so on. Junk bonds, sitting at the bottom of the ladder, are those with the highest risk, and thus the highest premium… until this economic expansion.

Figure 6. Source: Federal Reserve Bank of St. Louis – FRED

            Above is a graph depicting the spread between Moody’s Seasoned Baa-rated corporate bond yield and the 10-year Treasury note yield, in percentage points. While we remain above the record lows reached prior to the 2007-2009 recession, we continue trudging further down the scale. This depression of the spread indicates investors are willing to receive less of a premium to hold these risky bonds over U.S. Treasuries, as investors continue to hunt for yield.

            At first blush this chart is not all that impressive, but let’s view it in tandem with Figure 5. The Baa-10 year Treasury spread in Figure 6 is low, but the effective yield of BAML’s High Yield corporate bond index is at or near record lows. So, while the premium for Baa corporate bonds isn’t as low as it was in 2006, the actual yield of those Baa corporate bonds is lower, leaving investors with less income overall. That drive for income we discussed earlier only pushes investors deeper into riskier segments of the financial markets, and makes them more willing to take on risk to receive income. This is an intended consequence of the Federal Reserve’s QE program, but it’s a consequence that is beginning to lead to deteriorating credit conditions.

Credit Boom

            The Federal Reserve’s intent to make investors become more willing to take on risks has combined with the Federal Reserve’s lowering of borrowing costs to increase lending to make a dangerous entity in high yield bonds and leveraged loans. Let us first review the volume of total U.S. corporate bonds, U.S. leveraged loans, and U.S. high yield bonds in a historical sense, respectively.

Figure 1. Source: Bloomberg.

Figure 2. Source: Bloomberg.

Figure 3. Source: Bloomberg.

            It is not difficult to ascertain the trend in the broad corporate bond market. As shown in Figure 1, we are already well past the previous year-to-date record of U.S. corporate bond issuance, with just over $1.7 trillion in corporate debt issued through mid-November. The same is found in the leveraged loan market, with volume once again surging past the previous year-to-date record to clock in now at $1.2 trillion. We are not yet at a new year-to-date record in the U.S. high yield sector, currently in at $300 billion through mid-November. It remains to be seen if a new year-to-date record will be achieved in 2018 or later, but is unlikely to happen this year.

            The volume of these riskier loans is a testament to investors’ increasingly-frenzied hunt for yield. Unfortunately for investors, this has placed the bargaining power in the hands of the lender & debt issuer, given if one investor doesn’t like the terms, another investor that is more driven for income will take those same terms. This has led to a startling deterioration in the quality of investor protections on high yield and leveraged loan securities, as evidenced in the following quote from a Bloomberg article:

“Protections have gotten so lax in the $1 trillion market for U.S. leveraged loans that if an offering comes with decent covenants, lenders take it as a sign that something’s wrong with the deal.

“You do have to think twice when you see a loan with a covenant these days,” says Thomas Majewski, managing partner and founder of Eagle Point Credit Management.

It’s not a crazy assumption in a market where 75 percent of new loans are now defined as “covenant-lite,” meaning a company could, for example, rack up as much debt as it wants regardless of its performance. In such a lenient atmosphere, the reasoning goes, a loan must be a stinker if a borrower has to resort to promising even standard protections.”

            Source: https://www.bloomberg.com/news/articles/2017-09-21/safety-becomes-stigma-in-loan-market-that-s-ditching-covenants

Speaking from a common sense viewpoint, one could (and perhaps should) find it alarming that investors continue to eat up leveraged loans which come with increasingly fewer protections for investors. The phenomenon is not limited to the United States, either – in Europe, “cov-lite” loans have emerged as a popular security for those searching for income – despite a different name, the concept of less protection for investors is the same.

Moody’s, which publishes its Covenant Quality Index, has also noted the decline in protections for investors.

Figure 4. Source: https://www.bloomberg.com/news/articles/2017-09-21/safety-becomes-stigma-in-loan-market-that-s-ditching-covenants

            Another quote from the aforementioned article, this time from a Moody’s executive, once again strikes a risk-averse investor as quite alarming.

“ “It’s basically the worst it’s ever been in terms of loan covenant protections,” says Derek Gluckman, senior covenant officer at credit-rating firm Moody’s Investors Service. And that includes the heady pre-crisis year of 2007. ”

Conclusion

It is a sense of dread that many may have felt when looking back on the subprime mortgage industry after it succumbed during the financial crisis. Back then, investors were also hunting for extra income, and the issuance of such securities seemed to benefit all parties involved: the issuer, underwriter and trader for the associated fees and profits, and the homeowner for getting a home. But, of course, it all came crashing down when those investors began to realize just how deteriorated the subprime loans have become.

            It is important to distinguish between the subprime crisis, which was severely exacerbated by a lack of regulation and truly abhorrent lending practices, and this concern over riskier sections of the fixed income market. It remains to be seen how these deteriorating leveraged loans and high yield corporate bonds will fare when (not if) financial conditions begin to tighten. The Federal Reserve is expected to once again increase interest rates next month, and gradual tightening of monetary policy is also expected through the Federal Reserve’s balance sheet tapering. While it remains plausible companies are able to rein in the weakest links of such deteriorating credit instruments, history tells us it’s far more appetizing for both the corporation and the investor to put profits first and handle the consequences later.

Economic Data Continues to Suggest Late-Stage Business Cycle

A review of economic data continues to suggest the United States is in the late stages of the current economic expansion of the broader business cycle. We'll begin analysis of the economic data with monthly job openings for total non-farm jobs.

Source: FRED of St. Louis

Shown above are total non-farm job openings for the United States since just before the recession that began at the turn of the century. Increasing job openings indicates increasing opportunities for the unemployed to find a job, and thus signals a healthy (or at least improving) economy. This phenomenon is seen in the aftermath of both the dot-com bubble recession and the 2007-2009 recession (shaded gray areas).

I input a trend line (red), from the nadir in job openings after the 2007-2009 recession to around the value reached in April 2017. This is to show the general slope of job openings so far, and can be used practically by watching for any sudden deviations from the trend line, for example if the number of job openings were to suddenly skyrocket or plummet.
I also input a shorter-term trend line (green), which begins January 2015 and ends May 2017, the last recorded data point. Note how the slope of this new line is notably lower than the slope seen throughout the entire economic expansion. While we can visually see the values still oscillate around that red slope line, the recent trend has been to see momentum in job openings slow. The green trend line is meant to show that while the number of job openings still appear to be expanding, indicating some slack in the labor market, the momentum of this upward trend may be beginning to falter, a typical symptom of the late stage of an economic expansion of the business cycle.

One data set is not nearly enough to validate such a claim, of course, so we'll now expand our view into a few more parameters.

Source: FRED of St. Louis

To broaden the scope of parameters that generally track the business cycle, I created a graph composed of total non-farm job openings, levels of commercial and industrial (C&I) loans from all commercial banks, total vehicle sales, and the unemployment rate. These parameters are shown in the lines colored blue, red, green and purple, respectively. Additionally, note that these lines do not use the raw data numbers (e.g. job openings in thousands of people or unemployment rate in percentage), but instead are made into an index. In other words, I have set each parameter to show an index value of "100" at their respective nadirs during or immediately following the 2007-2009 recession. By using this index format, we are better able to track slowing momentum and potential turning points in these business cycle-sensitive parameters.

Commercial and Industrial Loans, All Commercial Banks
Since the total non-farm job openings parameter has been analyzed above, we now take a look at commercial and industrial loans created by all commercial banks, as aggregated by the Federal Reserve. For this parameter, the index value of "100" was set for October 2010, the lowest point in C&I loans resulting from the 2007-2009 recession.

Loan growth was originally negative following the end of the recession, as seems to generally happen following economic recessions (see a similar phenomenon occur following the early-2000s recession). Loans picked back up around 2011, and has been on the uptrend since. While I have not drawn out a trend line, you can see the relatively steady upward slope in C&I loans from ~2011 to the start of 2016. From 2016 until today, however, we note that the level of commercial and industrial loans given by commercial banks has plateaued. It is possible this stems from businesses not needing any further credit, having had the last eight years to enjoy economic growth. It is possible loan growth has slowed as businesses are no longer as confident about the future to significantly invest in long-term plans via loans. There is a wide variety of possible triggers for this plateau, but no matter the true reason(s), C&I loan growth has indeed appeared to hit a plateau.
This is similarly symptomatic of a late-stage economic expansion, as companies (again, for unknown reason(s)) begin to curb their loans. Should this be a protracted phenomenon, the lack of strong investment in long-term growth plans could hamper the current economic expansion.

Total Vehicle Sales
Vehicle sales are seen as another indicator of the business cycle, for their widespread usage by consumers but also their position as a durable good. As a durable good, vehicles will generally be purchased when consumers are upbeat about the economy and have ample funds. Consequentially, vehicle sales track the business cycle. For this parameter, the index value of "100" was assigned to February 2009, the nadir of sales amidst the recession.

Similar to C&I loans, it is not difficult to visually draw a line from February 2009 to roughly mid-2015 where the growth / slope line of vehicle sales was stable and strong. While 2015 and 2016 both saw record vehicle sales, the years also saw the emergence of a plateau as vehicle sales jumped from 16.9 million in 2014 to 17.8 million in 2015, followed by 17.9 million in 2016. Analysts have noted poor vehicle sales numbers so far in 2017, at least relative to the prior record-setting year. The apparent retreat of consumers from vehicle purchases may suggest less confidence in the economy, a preference to save money, or other reasons. Again, the reasoning may be unclear, but the data once again shows a characteristic of a late-stage economic expansion.

Unemployment Level
This parameter isn't shown here to be scrutinized for a plateau so much as a slowing in momentum. Note in the early-2000s recession and the 2007-2009 recession that the unemployment rate only began rising notably in roughly the middle of each recession. Consequentially, the unemployment rate appears to be a bit of a lagging indicator. Thus, to identify a late-stage economic expansion, we would be seeking continued downward movements (signaling lower unemployment) but at a slower clip than before. The unemployment rate index was set to "100" for October 2009.

It's not difficult to see that we have entered a lower grade of momentum for a decreasing unemployment rate, the expected signal of a late-stage economic expansion. Since this is more of a lagging indicator, analysis is somewhat less clear than C&I loans or vehicle sales, but we can still see here that the labor market is approaching full employment, which would likely signify the peak of the economic expansion.


We've now gone over a handful of broad economic indicators and seen that there are some red flags pointing towards the United States currently in the ending stages of the economic expansion. A personal favorite of mine is to look at delinquency rates for various types of loans, as delinquency rates typically increase prior to the official start of a recession, as defined by the NBER. Once again, I have set the parameters to indexes and set the index value of "100" at each parameter's respective nadir during or immediately following the 2007-2009 recession.

Source: FRED of St. Louis

In this chart, I have shown a number of delinquency rates:

• Delinquency Rate on All Loans, All Commercial Banks (dark blue, index=100 at 2010 Q1)
• Delinquency Rate on Loans Secured by Real Estate, All Commercial Banks (red, index=100 at 2010 Q1)
• Delinquency Rate on Credit Card Loans, All Commercial Banks (green, index=100 at 2009 Q1)
• Delinquency Rate on Commercial and Industrial Loans, All Commercial Banks (purple, index=100 at 2009 Q3)
• Delinquency Rate on Consumer Loans, All Commercial Banks (turquoise, index=100 at 2009 Q2)

These various delinquency rates cover a rather broad area of delinquent loans (e.g. the Delinquency Rate on All Loans), but also on more focused portions of the economy (e.g. Delinquency Rate on Credit Card Loans). I won't go into detail on each individual parameter here because they're all not too dissimilar from each other, but it's quite apparent that prior to the last two recessions, we have seen delinquency rates across the board first lose downward momentum, and then begin rising in the months before the recession's official start. 

This trend of a trough, followed by rising delinquency rates prior to the official start of a recession is seen across the board for the five delinquency rates graphed above. In recent months, we have seen mixed indicators. For instance, the Delinquency Rate on All Loans and the Delinquency Rate on Loans Secured by Real Estate are exhibiting some slowing downward momentum, but the delinquency rates on credit card loans, C&I loans, and consumer loans appear to be rising. With these mixed signals not allowing us to say that a recession is definitely on the horizon, these delinquency rates do appear to show a late-stage expansion.

There are other economic data we could observe that both support and deny the assertion that we are in a late-stage expansion of the business cycle, but with the consensus seeming to revolve more around the confirmation that we are in a late-stage economic expansion, it's worth more to see if that is indeed the case than to decide otherwise and potentially be burned by that ignorance.

In sum, I do believe we are in the late stage of this economic expansion- an accusation that has been made before to no avail, but this time supported by economic data. 

Andrew

Dollar Bulls Will Ride Again... If Not Now, Then Soon...

Dollar Bulls Will Ride Again... If Not Now, Then Soon...

MyFxBook

There's some shifting going on in the currency markets, especially in major currency pairs. The first image shows latest readings of the Euro (currency pair EUR/USD), which is currently in the retesting phase of a true 'head-and-shoulders' pattern. This pattern is identified by a rise in the value of a security, followed by a dip, followed by another rise, followed by another dip, and a final rise and a final dip to give the appearance of a head and two shoulders.
In the finance world, this is a 'bearish' pattern, a pattern that anticipates the value of the security will fall soon. The 'retesting' is shown right now, as we see the value of the security hovering just under that red line, called the 'neckline'. When this retesting is complete, which will happen soon, the Euro is expected to fall in value yet again, likely into the rest of January and February.

MyFxBook

The second image shows the value of the Yen (currency pair USD/JPY). Notice another neckline shown by that red line, but this time it is an INVERSE head-and-shoulders pattern. It's that head-and-shoulders pattern, but turned upside down. Similarly, instead of being 'bearish', this pattern is 'bullish', anticipating the value of the security will rise soon. Thus, the Yen is expected to decrease in value again in the near future.

Teletrader.com

It's no coincidence that these two things are happening at the same time. When the Euro and Yen both fall in value, as is projected to happen per this technical analysis, it's typically due to the U.S. Dollar strengthening. The third image (the Spot Dollar Index, symbol DXY) shows what may well be a very messy inverse head-and-shoulders pattern in the short term, using the same time intervals as the first two images, but again it's very messy. The messy quality of this pattern throws into question a strengthening dollar.

But this question exists only briefly.

In my fourth and final image, I show you what will be a news story for the next several years. We are currently going through, if not just exiting, the retesting phase of an inverse head-and-shoulders pattern in the Spot Dollar Index, but this time it's a 20-month-long pattern instead of just a couple of days, like the first three images.

Teletrader.com

It will be a consistent news story, because it could very well usher in the next recession. A stronger dollar for the long term is favored strongly by this technical analysis in the fourth image. While it increases purchasing power of the U.S. consumer, it will increasingly trim profits of multinational companies, especially those who make the majority of their revenue from other countries. Converting those currencies into a stronger US Dollar will take more of that country's currency to make 1 USD. Over time, that hurts companies' earnings, and by extent their stock prices.
The stronger dollar will force the Federal Reserve to hike overnight lending interest rates faster than they want to, something that will squeeze the bond bull market (which is already looking shaky post-election). For companies that have been living off of easy monetary policy put into place by the Fed since the Recession, this is a big threat. If it comes to fruition is another question and another story for another day, but the threats are very real.

To summarize:
1) Short-term weakening is expected for the Euro.
2) Short-term weakening is expected for the Yen.
3) Simultaneously, strengthening is expected for the U.S. Dollar.
4) Long-term, the U.S. Dollar is expected to strengthen, and may very well be the catalyst for the end of this already very-long economic expansion.

Andrew