USD Index To Mark Higher High, Aussie To Threaten Yearly Low

DJ FXCM Dollar Index

The Dow Jones-FXCM U.S. Dollar Index (Ticker: USDollar) extended the advance from earlier this week to reach a fresh monthly high of 10,027, and remains 1.00 percent higher from the open after moving 100 percent of its average true range. As the ongoing turmoil in Europe bears down on market sentiment, we should see the shift away from risk-taking behavior prop up the reserve currency, but we may see a short-term correction in the index before the USD continues to push higher. As the 30-minute relative strength index climbs above 70, the recent momentum in the greenback may gather pace throughout the North American trade, but we should see the dollar consolidate once the oscillator falls back from overbought territory. In turn, the upper bound of the current channel may serve as support as it coincides with the lower Bollinger Band (9,941), and the greenback looks poised to retrace the sharp reversal from 10,134 as investor confidence falters.

As the USD clears the 61.8 percent Fibonacci retracement around 9,947, the greenback looks poised to make a run at the 78.6% Fib around 10,117, but the downturn in market sentiment could taper off as global policy makers increase their efforts to shore up investor confidence. Indeed, the Federal Reserve laid out a more stringent stress test for the U.S. banking system in light of the heightening risk for contagion, and the measures may help to prop up market sentiment as the central bank works to shield the world’s largest economy from the debt crisis. However, the ongoing turmoil in Europe may continue to weigh on investor confidence as the EU struggles to meet on common ground, and the European Central Bank may have little choice but to expand its nonstandard measures further as the fundamental outlook for the euro-area turns increasingly bleak. Indeed, market participants see the ECB taking additional steps to balance the risk for the region, but we may see the Governing Council continue to target the benchmark interest rate as there appears to be a growing rift within the committee. According to Credit Suisse overnight index swaps, investors continue to price as 60 percent chance for a 25bp rate cut in December, and the central bank may carry its easing cycle into the following year as the region prepares to face a ‘mild recession.’

All four components weakened against the greenback, led by a 1.49 percent decline in the Australian dollar, and the high-yielding currency could face additional headwinds over the next 24-hours of trading should risk sentiment deteriorate further. As the AUD/USD slips to a fresh monthly low of 0.9663, the pair may make a run at the 50.0% Fib from the 2010 low to the 2011 high around 0.9550-60, but the pair may ultimately threaten the rebound from 0.9390 as market participants see the central bank taking additional steps to shore up the isle-nation. As the slowdown in global trade dampens the outlook for future growth, the Reserve Bank of Australia is widely expected to lower the cash rate by another 25bp in December, but investors see borrowing costs falling by more than 150bp over the next 12-months according to Credit Suisse overnight index swaps. As interest rate expectations deteriorate, the near-term outlook for the Australian dollar remains bearish, and the high-yielding currency may trend lower over the remainder of the year as the shift away from risk-taking behavior picks up.

--- Written by David Song, Currency Analyst

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

Join us to discuss the outlook for the major currencies on the DailyFX Forums