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US Dollar Index (DXY) Forecast: The Significance of Breaking Polarity

US Dollar Index (DXY) Forecast: The Significance of Breaking Polarity

2018-01-29 10:09:00
Tyler Yell, CMT, Currency Strategist
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US Dollar Index (DXY) Talking Points:

  • US Dollar Index Technical Analysis: takedown of 2009 high at 89.71
  • Dollar susceptible to further losses on increased risk-premium from tough trade talk
  • Trader Sentiment Highlight from IG UK: EUR/USD bearish bias weakens from retail favor ST dips

Traders are often warned not to catch a falling knife. The Dollar is fitting this description very well as a handful of fundamental levels seem to argue for buying the dollar, but a handful of components continue to argue that USD weakness my persist.

The charts paint an intriguing argument to avoid ‘buying low,’ while the fundamental background adds further color. Traders, of course, have to be on the watch for evolving fundamental backdrop that is often expressed through a momentum blast-off on the chart. However, this development has remained absent from the US Dollar.

Instead, the current environment favors traders not to question whether or not they should buy the USD, but rather, which should the sell the US Dollar against. There are multiple arguments for various US Dollar short position plays. Emerging markets continue to hold the best argument as commodities and inflation expectations rally while the developed market currencies like the Japanese Yen and Euro continue to benefit from a view that inflation expectations are pushing toward the top of their comfort range given the amount of bonds they hold. Such a development could cause them to pull back on bond buying and thereby increase the strength of their respective currencies against the USD.

DXY Breaks Polarity Point of March 2009 High

A polarity point happens when prior resistance (typically a spike high or series of highs) converts into new support meaning that traders are unwilling to sell below a certain level. A polarity point helps to show that the market is in the process of developing a technically new understanding of how a market should trade. When a polarity level breaks, the market is seen entering into a new understanding of the value of that currency. We recently saw a ‘new understanding’ develop in the US Dollar Index (DXY.)

The key polarity point that broke for the US Dollar Index was the March 2009 high at 89.71. Markets aggressively bid the US Dollar up through this level at the close of 2014 and the markets appeared content to keep the US Dollar at this “new normal” until now.

From a technical standpoint, a lot of traders viewed that the dollar was a cheap buy in the view that the polarity point would hold. However, the breakdown through the polarity point could show that a cheap US Dollar may soon get cheaper as the EUR (57.6% weight of the Dollar Index basket) continues to trade higher and institutional buying of EUR hasn’t been slowing down.

DXY Technical Update

The key technical level on the US Dollar is the 2018 opening range high that was traded at intraday on January 9 at 92.27. Given the bearish momentum picture, traders would do best to heed the impulsively bearish momentum at present and continue to favor further DXY downside for now.

The next focal level will be a trendline drawn off the 2011 and 2014 lows that currently holds at 8,880. The current price of US Dollar Index is trading near this level, and a further breakdown and weekly close below this zone would further embolden the bears to keep selling pressure going.

The dollar’s struggles are not going away and flow into other economies argues that USD weakness will persist. While there were arguments for short-term USD strength, they continually failed to materialize showing that pressure remains and US Dollar Index weakness remains preferred.

Short-term resistance is at the opening range high at 92.27. Below these levels, momentum prevails to favor focusing on the 2013 high and 78.6% retracement at 85/84.87.

Please add a description for the image.

Chart created by Shaun Murison, CFTe. Tweet @ForexYell for comments, questions

Unlock our Q1 forecast to learn what will drive trends for the US Dollar through 2018!

Insight from IG Client Positioning: Volatility in short positioning favors short-term dip before advance

EUR/USD sentiment is analyzed for insight since EUR/USD makes up 57.6% of DXY.

Please add a description for the image.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EURUSD prices may continue to rise. Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current EURUSD price trend may soon reverse lower despite the fact traders remain net-short.

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Written by Tyler Yell, CMT, Currency Analyst & Trading Instructor for DailyFX.com

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Contact and discuss markets with Tyler on Twitter: @ForexYell

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

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