The US Dollar Index (USDX) is an index that measures the value of the US Dollar relative to a basket of foreign currencies (EUR, JPY, GBP, CAD, SEK and CHF).
In 2008, the Index has hit its historical low levels as the US Dollar has been hammered while oil, gold and commodities prices were soaring. Analysts and investors still consider that the negative correlation between the greenback and commodities is valid.
Fundamentally, the global economic outlook has not changed since the correction started around mid-July. Therefore it makes sense to admit that the current price actions on both currencies and commodities markets are based on charts and technical analysis.
The US Dollar went too low too fast according to the market, especially while the Euro-zone struggles with weak growth and high inflation. Market players also consider that the fundamentals do not justify the recent rising prices on energy tangible assets; that Asian demand may slow, and that speculators have driven the price up too high.
As a result, the charts recently illustrated this with obvious oversold levels on the US Dollar. From the high posted in July 2001 (at 124.365 points) to the recent historical lows (posted last April and last July), the US Dollar Index has lost more than 42% of its value.
Where the current correction could lead the Index?
Let’s have a look at a daily medium-term chart. Broadly speaking, the Dollar Index has been declining since July 2001, as mentioned above. Only one significant countertrend occurred during this 7-year period, it is when the Index bounced back during the year 2005. A consolidation phase followed during the 9 first months of 2006, and then a new bearish trend started, backed by the global commodities boom.
The historical low has been posted on April 22 this year, at 71.455 (point B on the chart). The Index rebounded slightly and then slid back to this low level on July 15 (point C on the chart) before rebounding sharply. It’s a double-bottom pattern which constitutes a solid support basis for the price action.
Consequently the Index has been climbing by roughly 8% over the past month. It is now at 77.35. However a pull back is more than likely soon. Indeed, this sharp rebound is not sustainable at the current pace. A trend is always the succession of different waves and of corrective moves.
Two elements argue for a short-term pull back. First the oscillators show obvious overbought levels. The 14-day RSI has jumped above 85, which has not occurred since 1997. Second, there are two intermediary resistance levels that should convince investors to sell back the US Dollar.
The current level is indeed the 38.2% Fibonacci retracement ratio of the last bearish trend occurred between October 2006 and April 2008 (between point A and point B).
A further move up would lead the Index towards other resistance levels. 78.5 is the level of a significant previous low posted on the last day of 2004 (point D). As previous lows often become new highs, there is there some potential US Dollar sellers ready to take advantage of a pull back.
In this scenario, the Index may fall back to 75, where there should have some intermediary support. It would be a healthy correction and a new basis for a further bullish momentum.
[Please note: neither the authors nor any of the employees of Port Phillip Publishing own shares in any of the stocks discussed in Money Morning. The articles do not give trading or personal investment advice, but are intended to provide a useful, independent news and analysis service to supplement your own investing and trading. Consult your financial advisor before making any investment decisions.]