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US Dollar Index Forecast: Every Hike Takes Us Closer to Cycle’s End

US Dollar Index Forecast: Every Hike Takes Us Closer to Cycle’s End

2018-09-26 17:00:00
Tyler Yell, CMT, Currency Strategist
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US Dollar Index (DXY) Rate Forecast Key Points:

  • The ONE Thing: The Federal Reserves FOMC meeting will allow traders to glimpse into 2021 projects for the first time, and has the Fed meeting with an expectation to raise rates and signal more in the future despite yields being at cycle highs. The dovish risk (US Dollar downside) that traders should note is whether the 2021 DOT is in lockstep to the 2020 median dot or communication about policy no longer being accommodative.
  • Correlation analysis to EUR/USD (57.6% weighting of DXY) and Euribor time spreads (market expectations for ECB rates in 2019) seem to show itself as a bigger driver of USD and EUR/USD than what has already been priced in from the Fed’s DOT Plot.
  • Institutional US Dollar long positions remain at 1yr extremes of long positions despite the recent pull back. Extreme non-commercial positioning tends to be susceptible to changes in outlook. In other words, any dovish surprise could lead to a sharp US Dollar repositioning that favors downside in DXY.
  • Technical Outlook on the US Dollar: The US Dollar has retraced 38.2% of its February to August range in a three-wave pattern. It is possible that we’ve seen all the weakness we will see in the US dollar, but that is not my primary view. Rather, I will look for another leg lower in US Dollar Index that could be accompanied by a EUR/USD move higher toward $1.2075.

Unlock our Quarterly forecast to learn what will drive trends for the US Dollar through the rest of2018!

Key Technical Levels for the Us Dollar Index:

  • Overall Bias: Bearish on a potential continuation lower toward 61.8% retracement of
  • Resistance: 94.47/31 – minor range between wave iv and i, 50% retracement on September move lower
  • Spot: 93.77
  • Support: 93.36, short-term triple bottom, 38.2% of Feb-August advancement

Get ready for a lot of charts. We’ll be taking a look at the all-important US Dollar. Not important in the sense of Trump, but more in the sense of 9/10 global trades in FX are done with the US Dollar on one side. The direction of the US Dollar matters as does the next move the develops after the Federal Reserve meeting that should set the tone for the rest of the year.

Short-term US Dollar Index Chart: Key Range at 93.40/94.40

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Chart Source: Pro Real Time with IG UK Price Feed. Created by Tyler Yell, CMT

The short-term picture shows a range of focus between 94.40 and 93.40 on the 15-minute chart. A break through the bottom of this range would argue for a risk-on environment (as significant US Dollar strength has caused mass stress in global funding markets, specifically EM) likely well into Q4. However, traders of the Elliott Wave persuasion could well argue that we’ve seen three completed waves from the August high lower, and that high times (not the Tilray kind) for the USD are just around the corner.

If we were to see a breakdown at 93.40, traders should look to EUR/USD moving toward 1.2075, which is the 61.8% retracement of the 2018 move lower.

ST EUR/USD (57.6% Weight of DXY) Possible Trading Pattern

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Chart Source: Pro Real Time with IG UK Price Feed. Created by Tyler Yell, CMT

Combining the above short-term EUR/USD chart with the short-term DXY chart would have my focus on EUR/USD holding above $1.1680 (the end of triangle wave iv) and the Dollar Index holding below 94.40. What’s important about this pattern is that we could see a sharp resumption in the next week on the trade that could take us toward ~$1.2075.

To be fair, a break below $1.1680 on EUR/USD and a break above 94.40 on the US dollar Index would signal that the larger 2018 bull trend in DXY from February-August is soon returning, which would likely be correlated with a jump in Volatility as evidenced in the VIX and MOVE indices.

A Broad View of US Dollar Index (Daily Chart) Trading Atop Support

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Chart Source: Pro Real Time with IG UK Price Feed. Created by Tyler Yell, CMT

This chart looks to the broader US Dollar Index back from the terminus of the 2017-early 2018 downtrend that reversed magnificently on the back of the risk-heart attack witnessed by markets in early February.

We’ve recently retraced 38.2% of that move higher from February, which could mean the corrective (DXY move lower) is finished. However, the key path that I’ve witnessed traders get in trouble with Elliott Wave is to call an end to a move prematurely. A fate I’ll work to avoid today as well.

If the price of DXY breaks below 93.40, and the longest institutional positions in the Dollar Index begins to shrink back, I’d be on the watch for a move toward the 50-61.8% of the 2018 range that would take the price of the index toward 93.3-91.2, a massive 110 point range that is much lower than the current levels.

Institutions Per CFTC Hold Largest DXY Position In 52-Weeks

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Chart source: CoT Weekly Update: GBP/USD, AUD/USD & Other Major Markets

Again, markets would likely celebrate such a move as a weaker US Dollar tends to ease global market risk sentiment, and traders could likely see a further rise in APAC equities like the CSI300 in such a scenario or a further rebound in other EM FX charts.

Daily EUR/USD (57.6% Weight of DXY) May Have Further Upside

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Chart Source: Pro Real Time with IG UK Price Feed. Created by Tyler Yell, CMT

The chart above is a daily chart of EUR/USD, which Jeremy Wager, CEWA-M has covered in detail, but I’ll also add some to the view. Since bottoming in August, it has traded higher toward the top of the corrective triangle (labeled ‘iv’) on the chart above.

A break higher, which would be favored on a DXY index move below 93.40 could see price trade higher in the channel toward 1.2075, the 61.8% retracement of the 2018 range, and the top of the channel that has framed the bounce.

If Not The Fed, Then Who Is Driving DXY?

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Data source: Bloomberg

The blue area above is the expectations in tightening of monetary policy over 2019 by the European Central Bank. The overlaid orange line is an inverted DXY. The message here is that there is a strong correlation between DXY (again, heavily weighed by EUR), and ECB expectations of the market.

On the back of Draghi’s ‘vigorous inflation’ comment, we could see further tightening expected (though this is a stretch,) that could take DXY lower (EUR higher) if the +0.8 20-day rolling correlation coefficient held.

This is a long-winded way to say while this Fed meeting will be important and what happens to the 2021 dot will get a lot of market attention, traders should watch the levels above, 93.40/94.40 as the market breaking through either of these could set the stage for Q4.

We’ll see.

New to FX trading? No worries, we created this guide just for you.

More DFX Support For Your Trading:

Are you looking for longer-term analysis on the U.S. Dollar? Our DailyFX Forecasts for Q3 have a section for each major currency, and we also offer an excess of resources on USD-pairs such as EUR/USD, GBP/USD, USD/JPY, AUD/USD. Traders can also stay up with near-term positioning via our popular and free IG Client Sentiment Indicator.

---Written by Tyler Yell, CMT

Tyler Yell is a Chartered Market Technician. Tyler provides Technical analysis that is powered by fundamental factors on key markets as well as t1rading educational resources. Read more of Tyler’s Technical reports via his bio page.

Communicate with Tyler and have your shout below by posting in the comments area. Feel free to include your market views as well.

Talk markets on twitter @ForexYell

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

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