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US Dollar Reversal Staves Off Bear Trend, But Will Support Hold?

US Dollar Reversal Staves Off Bear Trend, But Will Support Hold?

2020-01-05 10:00:00
John Kicklighter, Chief Currency Strategist
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US Dollar Technical Forecast Talking Points:

  • The past few weeks have shown remarkable volatility for the Dollar, a function of liquidity
  • A few notable breaks from the DXY threaten a bigger turn, but is there conviction in the attempt?
  • Direction is the top concern for many, but what the Greenback truly lacks is traction for trend
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Technical Forecast for US Dollar: Bearish

Holiday trading conditions are often quiet, but the thinned liquidity can also inadvertently leverage volatility should the market’s experience external catalysts or systemic issues arise. Through the past few weeks, the remarkable swings seem to be a reflection of both concerns. Risk-based catalysts born of headlines like the US strike on the Iranian general and side effect from overnight funding gaps that the Fed has been battling generated remarkable swings, some large tails on various time frames and even some technical progress that seems to threaten long-term pacing trendlines. The question I have is whether seemingly critical technical breaks during such distorted conditions can secure conviction of a break or shift the perspective on months of congestion? On the flip side of that same coin, can traders afford to ignore the implications?

To get perspective of the volatility we’ve experienced these past few weeks, the Dollar basket’s daily chart reflects the conditions well. There were noteworthy tails on the specific December 25th and January 1st holidays which do not display here, but many would write these swings off out of hand. I would not as it suggests there are underlying conditions that make us prone to subsequent heavy swings in ‘normal’ markets. The tumble from the Dollar during the week starting December 23rd was particularly impressive with an eventual 6-day tumble that was the longest dive since April 2016. What was most notable though was the eventual break of trendline support that connected serious swing lows back to October 2018. Is this a tipping point or is the flat nature of the market these past years a little more ambiguous about where the point of no return stands?

This past Friday’s tail at least suggests a hearty bounce back into range is not a strong driver as an opportunistic path-of-least resistance. I will be keeping tabs on the series of lower highs developed over the past three months as a pressure gauge on the longer-term bullish conviction.

Chart of US Dollar Basket (Daily)

US Dollar Basket Price Chart

Chart created with the IG Trading Platform

On a higher time frame (weekly below), the general state of congestion is more recognizable. Though the currency has been generally trending higher these past two years, the pace has been decelerated markedly. From the 20-week average true range (ATR), the quiet is quantified with the most repressive activity levels since the Summer of 2014. These conditions are ‘too quiet’ and inevitably normalize, but there is nothing that suggests it has to be this coming week, January or even the first quarter of 2020. There are critical levels we should watch though. Congestion has created a 2019 head-and-shoulders pattern which is now bouncing off the neckline of the loose support we are still grappling with north of 9600 (96 on DXY). This is reinforced by a confluence of long-term 50% retracements (2017-2018 and 2001-2008).

Chart of US Dollar Basket with 20-Week ATR (Weekly)

US Dollar Basket Weekly Price Chart

Chart created with the IG Trading Platform

Looking at how the Dollar’s technical ambiguity is shaping up among the crosses, there is not a similar sense of recent critical breakdown from most of the crosses. For a number of pairs (like AUDUSD), key technical levels were pushed some time ago. However, the question of a break or hold was raised by EURUSD this past week. For this benchmark pair – the primary component of the basket – a reversal below 1.1250 was a hold. There is trendline resistance and its own set of Fib levels above in that vicinity. The drop over 36 hours was heavy, but end-of-day reversal left us with a large lower wick on Friday’s candle. Provocative more for volatility than intent in direction – especially when it is in the middle of a wedge.

Chart of EURUSD with 200-Day Moving Average and Wick Measure (Daily)

EURUSD Daily Price Chart

Chart created with the TradingView Charting Platform

Another Dollar-based major that was debating the cliff was USDJPY. In this case though, the Dollar bearish interests compounded and led to a break of congestion that had developed a wedge over the second half of 2019. The break below 108.50 may see the contraction in volatility build tempo if revived liquidity rebalances activity levels to historical norms. This is a break, but it is moving into a much larger, multi-year congestion pattern that stretches all the way down to 105.50/00. This may prove easier to traverse, particularly given this pair’s sensitivity to risk trends.

Chart of USDJPY with 100-Day Moving Average and 20-Day ATR (Daily)

USDJPY Daily Price Chart

Chart created with the IG Trading Platform

Another pair that showed a recent anti-Dollar break was USDCAD. Like EURUSD and USDJPY, there is remarkable, high level congestion from this pair, so there is constant monitoring for a critical break and shift from range to trend. On the daily chart 103.50 stood as a meaningful flatter trendline support with a few backing Fib levels, but there is still some higher level floor levels below which ware better observed on the weekly chart. If there is conviction in the selloff, we can break these figures to boost conviction behind the bears; but if it is just volatility, the floor is more likely to hold.

Chart of USDCAD with 20-Week ATR (Weekly)

USDCAD Weekly Price Chart

Chart created with the IG Trading Platform

Since it is clear that technical triggers are not automatically triggering follow through events, I think it is worth doing some technical analysis on fundamental influences. If you were to plot measures of risk trends (either S&P 500 for ‘risk-on’ or VIX for a haven perspective) against the Dollar, there is very little correlation in the charts. The same is true for practical economic health measures like the US Treasury 10-year to 2-year yield spread. Yet, one chart that aligns remarkably well with the Greenback still is implied Fed rates for 2020 derived from Fed Fund futures. The December contract is a good first level evaluation, but the December 2020 to December 2019 spread offers better measure as seen below.

Chart of DXY Dollar Index with Implied Fed Change for 2020 (Daily)

DXY with Fed Change Chart Daily

Chart created with the TradingView Charting Platform

EUR/USD BEARISH
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of clients are net long. of clients are net short.
Change in Longs Shorts OI
Daily 6% -7% 1%
Weekly 12% -20% 0%
What does it mean for price action?
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As for speculative positioning, there is a considerable split between the large futures and retail FX traders views on the Dollar. For the former, the COT report reflects on a longer average duration (they hold traders for a longer time) and bullish confidence continues to dive in a trend that has developed steadily over the past year as lift in the Greenback slowed. In contrast, retail spot FX traders measured in IG Client Sentiment has seen a swell in net short EURUSD (long Dollar) this past week that was the most extreme in over a year. Retail FX traders are eager to trade the range but concern that the break is coming is building among futures speculators.

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

COT Speculative Positioning

Chart of Retail Trader Positioning from IG Clients (Daily)

EURUSD Client Positioning

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