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What Now Can Hold Back the US Dollar? Breakout Deja Vu

What Now Can Hold Back the US Dollar? Breakout Deja Vu

2016-07-07 18:00:00
Tyler Yell, CMT, Currency Strategist

Bias: Long Dollar Is Beginning To Feel Like a Default Trade Again

Point to Establish Long Exposure: Stop Buy (Entry) 12,053

Spot: 12,015

Target 1: 12,214 February 29 High

Target 2: 12,306 2016 High

Invalidation Level: Close below 11,823 (61.8% of the Post-Brexit Rally)

Fundamental & Technical Focus:

The Federal Reserve doesn’t want the US Dollar to appreciate aggressively. That would be bad for “price stability.” Given the ramifications of US Dollar strength (weaker commodity prices and inflation), many other central banks feel the pain of US Dollar strength as well.

However, there is a building of evidence that the US Dollar has an increasing probability of moving higher. Here’s a breakdown of what may be worth watching as a collective “Tinder-Box” that could result in a higher-US Dollar:

  • CNH Weakness (What’s Behind The Move)
  • Market Pulling Away From CB desires
  • World Interest Rate Probabilities (aggregated by Bloomberg) show the shock potential is on the topside.
  • Commodity FX is stretched.

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This week, we’ve seen the value of CNH next to the US Dollar move to its lowest levels. In stealth mode, the People’s Bank of China has been moving down the value of the CNH to bring it in line with market realities. This inline move has seen the CNH fall ~8% YoY against the USD. A year ago, the CNH was the only currency that had steadily gained against the US Dollar since the Great Financial Crisis. If this trend continues, and there is little reason to think it should stop given the PBOC’s reserves and ability, we could see this continue to “grease the skids” for more US Dollar appreciation. So far, the ability to avoid panic in the manner we saw in 2015 has been impressive.

Secondly, we’ve seen a deep divide in how institutions have taken the bait from the Central Bankers that historically led to weaker FX and higher equity markets. The equity markets have largely moved sideways over the last 2-years, and yet the only market that has truly appreciated over the last two years is government debt. Such a trend in government debt is often borne out of a desire for safe, stable returns.

Third, we’ve seen markets go from keenly aware of when the Fed would hike next toward a collective malaise on the back of hollow rhetoric about tightening. Over the last 2.5 years, the market has been hanging on every word from Janet Yellen as to when we would see rate hikes really accelerated. For all the fuss, we had only seen a 25bp hike in December 2015, and what appears to be a consistent backing off of the 4-rate-hikes in 2016 prediction from the Fed.

We currently sit with the next “priced-in” hike from the Fed to happen in 2018. Even still, the US Dollar is sitting higher thanks in large part to the significance post-Brexit GBP depreciation. However, if the US Dollar can remain supported with no rate hikes “priced-in” for two years, it seems the market is buying USD regardless of the historical driver of the currency.

Lastly, the currencies that have been outperforming across the board in tandem are commodity currencies. Over the last three months, the New Zealand Dollar is up against the US Dollar by ~7% while the Canadian Dollar is higher by a little more than 1%, and the Australian Dollar is roughly flat.

Given the rise in risk off assets like XAU/USD or Gold, Government Debt, and the Japanese Yen, it is unlikely H2 2016 will be kind to commodity currencies if this trend continues. In aggregate, you should keep an eye on US Dollar performance because if the breakout occurs, we could see a further propulsion of US Dollar strength back toward and possible through the 2016 high of 12,306.

Chart:

What Now Can Hold Back the US Dollar? Breakout Deja Vu

US Dollar Resistance & Support Levels

2nd resistance: 12,306 2016 High

1st resistance: 12,214 February 29 High

Spot: 12,017

1st support: 11,823 61.8% of the Post-Brexit Rally

2nd support: 11,681 Pre-Brexit Low

While an entry in a breakout point may seem extreme, if this is the start of a new impulsive trade, then a breakout could be soon upon us. The trade’s target aligns with a favorable risk: reward ratio that our Traits of Successful Traders report found to be one of the best things a trader can do to ensure long-term sustainability in your trading.

A Short-Look At History: Revisiting 2013-2014 Base in the US Dollar

What Now Can Hold Back the US Dollar? Breakout Deja Vu

If you’ve gotten this far, you’re a rare breed, but it’s important from a technical perspective to see the similarity of the 2013-2014 base and the potential base of 2015-2016. The kickoff of the US Dollar on July 1, 2014, took off and did not look back until March 2015.

In July 2014, the fear was that traders would miss out buying US Dollars before the Fed hiked aggressively to normalize policy after quantitative easing. Now, the view that I’ve highlighted above for you could be the catalyst for the next strong move in the US Dollar to new highs.

Either way, if it happens, watch out and please don’t say we didn’t warn you.

Happy Trading & Please Let Me Know If You Have Any Questions

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