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US Dollar Forecast: New Year, Old Problems for DXY Index - Key Levels

US Dollar Forecast: New Year, Old Problems for DXY Index - Key Levels

Christopher Vecchio, CFA, Senior Strategist

US Dollar Forecast Overview:

  • It’s the first trading day of 2021, and the US Dollar has already broken 2020’s low. A bad omen? Maybe not.
  • The forex economic calendar this week is shaping up to be a potential hotbed of catalysts for a short-term US Dollar reversal higher.
  • Retail trader positioning sees more losses for the US Dollar vis-à-vis EUR/USD, GBP/USD, and USD/JPY rates.

US Dollar Starts Year with a Whimper

While a new calendar year, in reality, changes nothing, the simple turning of the calendar can be a psychological break for individuals, and concurrently, financial markets around the world. No currency is wishing more for a fresh start than the US Dollar, which has been on a nine-month losing streak (vis-à-vis the DXY Index) amid prolonged low interest rates and an expanding US federal deficit. Accordingly, the old problems that plagued the US Dollar in 2020 have not disappeared with the arrival of the New Year.

These appear to be bad omens. Yet the short-term winds could shift quickly, at least in favor of temporary US Dollar strength. With the Georgia Senate Runoff Elections tomorrow, the composition of the next Senate will be known, as will the state of gridlock in Washington, D.C.. A Democratic sweep (creating a 50-50 tie in the Senate, resolved by Democrat Vice President-elect Kamala Harris’ tiebreaking vote) would likely mean much more fiscal stimulus, and thus more pressure on US real yields, which has been negative for the US Dollar over the past nine-plus months.

But in the likely scenario that a Republican sweep keeps control of the Senate in Republican hands (52-48 margin), the prospect for more fiscal stimulus subsides fairly quickly, and so too does a significant downside pressure cultivating negative real US yields. Given how the market has been maintain a net-short US Dollar positioning in the futures market, a break in the negative-USD news flow could provoke a short-term reversal in the DXY Index at the start of the year – even if the prevailing, long-term view remains bearish.


US Dollar Forecast: New Year, Old Problems for DXY Index - Key Levels

The first trading day of the year (discounting the obligatory candle for January 1) has produced a fresh low in the DXY Index relative to 2020. The immediate November-December 2020 downtrend remains in place, while the DXY Index remains well-below the descending trendline from the March and November 2020 highs.

For now, the DXY Index has a bearish posture, even if bearish momentum appears weak thanks to price action around the holidays. The DXY Index is still below the daily 5-, 8-, 13-, and 21-EMA envelope, which remains in bearish sequential order. Daily MACD is flat, but still below its signal line, while daily Slow Stochastics are flat, hovering just above oversold territory.

If the DXY Index moves above 90 at all this week, then there could be a ‘reset’ in the market that sees the DXY Index return to the latter of these descending trendlines as January unfolds, potentially trading into the mid 91s before turning lower anew.


US Dollar Forecast: New Year, Old Problems for DXY Index - Key Levels

The longer-term view established in the latter half of December 2020 remains valid: “we thus view the latest development with hesitation, particularly when viewed in context of the longer-term technical damage wrought in recent months; the DXY Index remains below its multi-year uptrend, and could be working on a multi-year double top. So long as the rebound remains below 91.75, the DXY Index outlook remains bearish on a longer-term basis.”

IG Client Sentiment Index: EUR/USD RATE Forecast (January 4, 2021) (Chart 3)

US Dollar Forecast: New Year, Old Problems for DXY Index - Key Levels

EUR/USD: Retail trader data shows 32.37% of traders are net-long with the ratio of traders short to long at 2.09 to 1. The number of traders net-long is 4.06% lower than yesterday and 6.77% lower from last week, while the number of traders net-short is 22.29% higher than yesterday and 9.62% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

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