Pivotal Period For The Dollar

The movements of the US dollar index and the dollar against most major currencies over the past few days has caught the market’s attention. For the first time since early March when technical analysis of the dollar index indicated a top, daily technical analysis has now turned moderately in favor of the dollar, suggesting at least a short-term low has been made and short term dollar strength to come.

How significant is this low the dollar recently hit?

Figure 1

The dollar index marked a high in early March at 89.71 and hit a low nearly two weeks ago of 74.27. On these lows, the selling (for a change) was not as heavy as before with the on-balance volume (OBV) acting much stronger and forming a bullish divergence, line e. The initial OBV resistance, line d, was overcome and further new highs would be quite positive. A move in the OBV above the longer-term resistance at line c would be even more impressive. The daily downtrend at 76.70 should be tested this week, and a test of the 23.6% resistance at 78 is likely over the next week or so. Normally, I would expect the rally to stall in this area, but with the massive short dollar position, this may not happen. The first major upside target is the 38.2% resistance at the 80 level.

Figure 2

The weekly chart of the EUR/USD shows that the euro peaked at near 1.5142 nearly three weeks ago, falling short of the major 78.6% resistance level in the 1.5225 - 5275 area. The euro (through December 8) is testing the weekly uptrend, line a, and chart support in the 1.4630 area. There is additional support in the 1.4500 area. The weekly RSI formed a short-term negative divergence at the recent highs, point 2, and is likely to break its uptrend, line b, this week. At a major top, we would normally expect to see a divergence that was formed over a longer time period, but if one assumes that this whole rally was just a rebound of the 2008 decline, then it could end with such a short-term divergence. Typically, we would expect to see another one to three weeks on the downside and then a rally that would take the RSI back to its declining WMA. This could be an optimum dollar selling opportunity.

Figure 3

The daily analysis of the euro futures nicely supports the weekly analysis as the euro futures made marginal new highs last week, point 2, but the OBV was much weaker. This indicates that there were significantly fewer buyers than there were on the prior highs (point 1). The break of the uptrend in the OBV, line c, confirms the negative divergence as well as the break of the uptrend in prices, line b. I would not be surprised to see a strong rebound in the euro if support in the 1.4300-4350 area is tested (EUR/USD is currently rebounding strongly from just hitting 1.4305 a few hours ago). First resistance is now in the 1.4650-1.4750 area.

The next few months may be a paradigm shift for the dollar sentiment. With technical and fundamental factors conflicting, the real catalyst should be when the Fed becomes more hawkish (decrease money supply, raising rates), or when the major market indices break significant support levels. While nearly everyone is looking for the Fed to raise rates before the dollar can mark a new multi-year bottom, the technical outlook suggests that with the current position of the federal reserve policy the dollar has a good chance of hitting that new multi-year low below 70.5 on the dollar index before rates are raised in mid-2010.