Macro Viewpoint

The US Dollar has always been a very interesting and influential currency. After all, it’s the world’s reserve currency and the majority of all transactions on the planet are made using dollars. The dollar tends to run in long-term trends and the past 12-18 months of broadly sideways action suggest that it’s consolidating before the next big move. The million dollar question is: which way next?

The Federal Reserve held rates in September but clearly indicated that they will most likely hike by year-end. Yellen explicitly stated that the case for a hike had strengthened significantly. The market is currently pricing over 50% chance for a December hike but what’s really at stake now is not the next 25bps; it’s the Fed’s credibility. If they don’t hike in December the market will get very disappointed and essentially it may start to ignore the Fed members’ statements & forward guidance. After all, it will have been a year since the last hike and although Fed speak has been quite hawkish, there seems to always have been a reason for them not to pull the trigger again. Clearly this would be a huge blow for the Fed and the US dollar.

On the other hand, if the Fed hikes in December, it will place a bigger burden on the US’s slow economic recovery. It’s been almost 8 years since the financial crisis and even though the massive scale of economic stimulus has been unprecedented, the US economy has only managed a relatively weak trajectory so far. Some of the data has been impressive but if you look at the details it can look fragile. A good example of this is unemployment – the headline rate is very low and suggests a booming economy, but if we consider the LFPR drop and job quality trend, the picture looks quite different. Other important economic indicators (such as inflation and GDP) keep getting revised lower and this puts even more doubt in Fed members’ minds.

It’s likely that the December FOMC meeting will be the trigger for a move but it’s not just the rate decision that will be the market mover. It will be equally important to see what the tone of the post-meeting talk will be. They could easily deliver a 25bp hike but make a more dovish than expected statement. Given that the market is pricing a further couple of hikes, one can easily see a scenario where a dovish hike causes the dollar to weaken. Expectations for the long-term interest rate equilibrium level (the infamous “dot plot”) have been steadily lowered so the market may be overestimating the level of neutral rates. On the other hand, the strong unemployment and payroll data may give Yellen the confidence to push for a more aggressive hiking cycle and this will also surprise the market. The 10year UST yield is at around 1.70% and this indicates that the market certainly doesn’t expect rates to be moving materially higher in the near term.

In summary, it’s fair to say that the dollar is at an important junction. It takes guts to go against the world’s biggest economy, especially since it’s currently the only major western economy that’s in a theoretical hiking cycle. There are valid arguments to support a continuation of the Fed’s (shallow) hiking cycle and they cannot be ignored. On the other side, the risk of a further US economic slowdown is still high and could easily disappoint market expectations.

Technical Viewpoint

To properly examine the USD from a technical perspective we must first begin by analyzing the two USD indices, the DXY and the DJIA USDOLLAR index. Their main difference is the composition of the basket of currencies they include; to make a long story short, the DXY is monitored by the vast majority of the traders but since it preceded the formation of the EZ it is more EURcentric (after the EZ formation several different currencies included in it combined to the single currency). On the other hand the USDOLLAR index is better balanced and therefore a better indicator for the direction of the USD but tracked by fewer investors.

Examining the weekly and daily charts of both indices (which couldn’t be anything but highly correlated) we can clearly see 3 similarities. 1) both of them display the strong $ uptrend that started in the summer of 2014. For the DXY this lasted for 10 months  (May 2014 – March 2015) trough to peak. For USDOLLAR it lasted almost 1.5 years (July 2014 – January 2016). 2) Both indices ended the wild part of the ascend (Elliott Wave traders call that “an impulse”) in April 2015 and have since traded more or less within a wide range. 3) Following the uptrend, both indices have been trading within a broad range during the past 10 months. We have had some wild swings during those months but the fact remains that the $ (especially DXY) has been constrained within a range.

Despite the obvious similarities there is one striking difference that has drawn our attention. The DXY double topped in December 2015 while the USDOLLAR was registering higher highs and peaked 1 month later. The result is that the DXY is trading in a strictly defined range (93- 100.5) with the exception of 2 false breaks lower, (one intraday in August 2015 and one in May 2015) while the USDOLLAR expanded that range higher and seems to be forming what looks like a H&S formation. Obviously for this formation to actually prove to be a H&S formation a move lower to test and finally break the neckline (around 11700) is required, until then this can only be interpreted as a prolonged consolidation.

Taking a closer look at the daily charts of DXY & USDOLLAR and examining the shorter term technical picture, we can see that both indices have broken their S/T triangle consolidations to the upside. NFP’s are less than 24h away so that move might accelerate higher or it might reverse lower but in any case we will still be well within the past 8 months range. If that is the case then “how should I identify the direction of the next move?” someone might ask. The answer is by tracking important USD pairs that are very close to breaking out of a much tighter range. The currency pairs we are referring too are specifically the USD/CHF, the USD/CAD and the AUD/USD.

Below you can find the Weekly and Daily charts of DXY, USDOLLAR for which we have already written our comments above as well as the USD/CHF, USD/CAD and AUD/USD with accompanying comments.

DXY Weekly (Left) and Daily (Right) Charts

USDOLLAR Weekly (Left) and Daily (Right) Charts

USD/CHF (Weekly chart on the left and Daily on the Right)

First of all let us explain the reason for examining USD/CHF instead of the most popular EUR/USD. It is very easy to realize by checking a weekly chart that EUR/USD is almost inverse to the DXY and hence is trading within a very wide range (perhaps a triangle, time will tell). Contrary to the Fiber, USD/CHF has been trading in a contracting range since the 2011 all time low and within a triangle since May 2015 (we broke out of it temporarily when the SNB released the floor but that was just a whipsaw illiquid move). Just to give you an idea of the technical significance of this triangle, the resistance trendline has been tested in 5 different occasions (some of them lasted 2-3 days) during the past 10 months and has held. The range of the triangle has been decreasing (as expected since regular triangles are contracting formations) and is now down to less than 250 pips. A break out of this is imminent, NFP’s might easily provide the final push.

USD/CAD (Weekly chart on the left and Daily on the Right)

USD/CAD enjoyed a wild bull market that started 5 years ago (July 2011) before reversing (January 2016) and breaking down spectacularly. It bottomed in the beginning of May and has been consolidating since then in a contracting wedge that now has a 400 pip range (1.2930 – 1.3330). Examining the wedge closer we notice a strong horizontal resistance zone capping the upside during the past 2.5 months at 1.3250 and coinciding with the 200 daily moving average.

AUD/USD (Weekly chart on the left and Daily on the Right)

AUD/USD has been trading since December 2014 within (what later proved to be) a huge triangle. The market has tested the triangle resistance and support trendlines dozens of times since then (which proves their technical importance) and specifically has made several unsuccessful attempts during the past 2-3 months to penetrate the topside. The range of the triangle has now been narrowed to a negligible range of 200 pips and a break is imminent and unavoidable.

Stelios (Steve) Voulgaridis

Stelios Konto