by Ron William, CMT, MSTA
LAT Senior Lecturer & Trading Psychology Coach
It has always been assumed that the US dollar (USD) would be a haven of value and characteristically strong in troubled times, especially if stock markets entered a bear market. This was certainly the case in the crash years of 2008 and 2000. However, the same situation has not held true recently with large sell-offs in the traditional risk proxies such as the S&P500, being accompanied by a drop in USD.
Unsurprisingly, this disconnect coincides with the Federal Reserve now trying to slowly reduce its balance sheet and raise interest rates to levels that could be regarded as normal. Meanwhile, other central banks, such as the European Central Bank and Bank of Japan, are persisting with more aggressive easing of their money supply. The growing divergence naturally makes their currencies unfairly compete against the USD.
Against this backdrop, Mr Trump is determined to return the advantage back to the USA. His tax cuts are just the first step. The second step could be to allow and indeed encourage the USD to weaken. But what of the state of the invisible hand of market forces? Is the USD king dead or alive?
The Trade Weighted USD (DXY) chart (Fig 1.0 – panel A) does clearly show USD resuming its 2017 downtrend. In fact, it was as early as the month of May, when the greenback broke under its long-term 200-day moving average and triggered a bearish crossover signal (against its 50-day counterpart). This confirmed that it was now in a downtrend and not just consolidating its prior overbought condition. In percentage terms, the USD has dropped over 12% year-to-date, and 2017 is now officially one of the worst performing years since 2003.
However, technically speaking, there is growing reason to be alert for a USD revival. The old market adage “the trend is your friend” is only true until Mr Market signals a temporary change or end to the cycle. Turning points traditionally appear in overcrowded trades, which ultimately lead to price exhaustion. This price behaviour can already be seen, as part of a nearly completed 5-wave impulsive cycle, which would still require a new low under 91. Looking at the short-term picture, in September, a possible bullish reversal pattern (inverse head and shoulders) has also developed, supported by a golden ratio circular support. This could lead to a much stronger USD again, but only if it breaks above price resistance (old neckline support) at 96.
Nevertheless, it remains capped under this level for now. The wave pattern favours one final drop to at least 91 again. This is part of a 2.8-year trading range floor (Fig 2.0) and a 38.2%/50% Fibonacci retracement of the bull-trend from 2008 and 2014 respectively. Below 91 would risk a marginal new low, that would carve out the final wave 5, with further risk to 88. Only a further break of this support level would unlock further downside potential. As the DXY is heavily dominated by the euro, then we also expect the euro to have stronger price action. In the past week, price moves the other way have occurred to delay the day of execution, but USD still seems to be teetering on the brink of being dead or alive.