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Dollar Within Reach of Two-Year High but Reversal Pressure High

Dollar Within Reach of Two-Year High but Reversal Pressure High

2019-02-16 16:00:00
John Kicklighter, Chief Strategist
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Dollar Talking Points:

  • The DXY Dollar Index gained modestly this past week, slowing the fastest climb since Oct’s peak
  • Retail traders are heavily net long EURUSD – a short Dollar position
  • See the 1Q 2019 fundamental and technical forecast for the Dollar updated on our trading guides page

Technical Forecast for US Dollar: Bearish

The Dollar eked out moderate gains through the past week if you used the DXY Dollar Index as your benchmark. That puts much of the responsibility behind this lift on the EURUSD which is the heaviest weighting in the index. Elsewhere, noteworthy – but still restrained – gains were made for the Dollar through GBPUSD and USDJPY. These account for the three most liquid majors in the Forex market accounting alone for more than half of all currency-to-currency transactions around the world. Naturally, their influence would readily offset the Greenback’s losses against the likes of the Australian, New Zealand and Canadian Dollars. All told, however, the Dollar did not materially alter its bearings through the past week. It still falls comfortably within the rising trend channel stretching back over the past nine months. A bullish breakout will still require a move back to 97.75 (we end the week just below 97) and a true shift into a bear trend would come on a break of the same pattern’s floor and the 200-day moving average around 95.50. Anything in between those bounds could qualify as a path-of-least-resistance range swing.

Chart of DXY Dollar Index with 50-Day and 200-Day Moving Average (Daily)

DXY Index

Adding perspective to the default range setting we registered in the past week’s price action and the technical restrictions of the past months, the remarkable drop in priced-based activity has dropped to extreme levels. The 20-day (equivalent of one trading month) Average True Range, or ATR, for the DXY continues to hover around levels comparable to the 2017/2018 holiday season – and before that, there is no comparison until we stretch back to summer of 2014. While restricted volatility is to be expected given the range conditions we have experienced, this reading is extreme. And, extreme readings rarely last. Either market conditions are universally going to cool to levels commensurate with the complacency experienced in previous years of unchecked speculative reach, or the Dollar is going to see a charge in the near future. While breakouts are more likely to occur when activity levels are picking up, such an outcome is not a foregone conclusion.

Looking for a fundamental perspective on USD? Check out the Weekly USD Fundamental Forecast.

Chart of DXY Dollar Index with 20-Day Average True Range (Daily)

DXY Index 20 Day Average

If we are looking for the motivations that could reasonably leverage volatility and sustain it – whether to the ends of a critical breakout/down or simply violent range swings – the movement will likely start with more critical fundamental themes. Keeping tabs on these motivations doesn’t require a deep understanding of the economic calendar and abstract themes that are struggling for conviction (though if you want to learn how to trade news, you can read our guide on it). There are two general correlations that I am watching closely for guidance on the Dollar. In some ways, they are related. The implied yield forecast for Fed Funds futures is a measure of the outlook for ‘income’ return for the currency and thereby its appeal as a carry currency. Therefore, when risk appetite rises – as we would register from the S&P 500 as a reasonable baseline – the Dollar’s appeal would be magnified. That said, as interest rate expectations struggle, the S&P 500’s rally will have less pull for the Dollar. Yet, if equities were to drop, the disconnect would do little to dampen the negative impact on the currency itself. That puts greater fundamental influence – and volatility – behind bearish perspective.

Looking for a Fundemental perspective on the US Dollar? Check out the Weekly USD Fundemental Forecast.

Chart DXY Dollar Index Overlaid with Fed Funds Implied Rate and S&P 500 (Daily)

Fed Funds Implied

One alternative, big-picture fundamental driver that could cater to the Dollar’s further gains in a scalable way is the sustained broad decline in major USD counterparts. Should the Euro, Pound and Yen extend exceptional losses, the markets will generally move towards deeper liquidity. In that scenario, there is only one major counterpart that would fulfill the market’s needs: the Dollar. What motivates a universal loss in currencies, which can be hidden in relative exchange rates? A dovish turn in global monetary policy, a ballooning debt/deficit amongst global leaders, even speculative leverage itself. If you want to keep tabs on this influence, there is a good barometer in the value of gold. The metal has proven itself a preferred alternative-to-traditional-fiat in previous years and cycles, and that role has not changed. Gold is usually priced in Dollars which can offer some skew, but the equally-weighted pricing of the commodity in Dollar, Euro, Pound and Yen below doesn’t alter its course much.

Chart of Equally-Weighted Gold Index and 50-Day Moving Average (Daily)

Gold Index and 50 Day Moving Average

As for the look at positioning behind the Dollar, there is a conflict between the short-term and medium-term intentions – not unsurprising given the months of channel we have carved out. From the futures-based COT report from the CFTC, the (still by four weeks) delayed reading has shown the heavy net long interest built up through 2018 is finally starting to deflate. That said, the shorter-term picture from retail FX positioning via IG clients shows a strong net long EURUSD (short Dollar) view that suits the range established just over the past few months. When range conditions prevail, the speculative view from the retail crowd tends to be more timely while a shift to genuine break and trend is where the slower-to-align futures positioning is often more aligned.

Chart of Net Speculative Positioning in Dollar Futures Positions from CFTC Report (Weekly)

Net Speculative Positioning in Dollar Futures

Chart of Retail Trader Positioning from IG Clients (Daily)

EUR/USD Client Positioning

Other Weekly Technical Forecasts :

Australian Dollar Forecast – AUD/USD Eyes Resistance, AUD/NZD Resumes Fall, GBP/AUD May Bounce

Oil Forecast – The 2019 Crude Bull Market Has Arrived

British Pound Forecast – GBPUSD & EURGBP

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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