UPDATED (23-July-2020): Only a month has gone by since my last update to this blog post, but again a few things have changed, and I thought it worth flagging a couple of the key moving parts and some interesting recent insights.
Firstly, as flagged on Twitter, the US dollar index has broken down against its first key line of support. This is a key bearish development and could open the door for further and more sustained dollar weakness.
(and here it comes...) *BUT* anyone who has been paying attention will by now know intimately that the US dollar has had a penchant for delivering maximum pain and confusion to the maximum number of participants... in other words, we've seen a procession of fakeouts on both the bullish and bearish side, so while I am admittedly pleased to see price evolving in line with my core thesis, I am a tad reluctant to go full-happy on it just yet.
Anyway, enough talk, let's look at a couple of charts...
First one comes from my latest weekly report, it shows a clear and decisive turn in opinion on the US dollar index judging by the actual futures positioning of speculators (for reference, this also aligns with some of the other measures of sentiment I track).
The other thing to note is the bearish divergence between the index (higher highs) and the indicator (lower highs), which coalesced with the nascent turning point that seems to be developing in the DXY. So with the change in mood I would say that brings a certain element of bearish momentum.
Naturally the bullish take would be that sentiment has now undergone a healthy reset, and we can expect a rally. (but...)
Looking at the seasonality pattern for the US dollar index, there is an interesting tendency for the US dollar to generally trend down from around July through Oct/Nov, as the chart below shows (as a side note, gold - as you might guess - tends to do the opposite, which is certainly interesting with respect to what's going on over there).
Normally I wouldn't focus too much on seasonality as the averages can deceive and seasonality has a habit of breaking when you try to rely on it... having said that, I also say that when seasonality aligns with a broader thesis it can help boost conviction levels and the seasonal headwinds that seem to be swirling for the US dollar certainly at the margin dog-pile on with the rest of the building bearish evidence.
So what do you say? A "healthy reset"? Or the start of a more sustain and substantial bearish run for the DXY?
Medium-longer term I think the bearish case is compelling, and see promise in the shorter term price action and shifts in sentiment and seasonality, but again I do feel a little apprehension and sense it won't be a clear cut straight line...
Head of Research
UPDATED (17-June-2020): I wanted to revisit this blog post with an update, as a few things have changed since Feb (to say the least), a couple of themes are coming into focus, and something interesting is happening on the price front for the US dollar index.
First up is a look at that old chart of US dollar index vs FX market implied volatility indicator... volatility did indeed awaken from its slumber around previous record lows. But so far what is lacking is the big breakdown or breakout that often comes following such episodes (e.g. look at 97/98, 07/08, 14/15 -- to name the more notable examples).
One thing on the volatility front is the lift in what I would call a vague but multi-faceted umbrella term of US sovereign/political risk. I ran a couple of surveys on Twitter and LinkedIn, and there does appear to be some consensus that political risk is higher/rising.
Obviously there's the elections in November (the stock market risk is a clean-sweep by the Democrats: placing corporate tax hikes on the table), but there are also tremors of regulatory risk (e.g. some form of politically motivated regulatory intervention on big tech), geopolitics continue to simmer away in the background (Iran, Venezuela, North Korea, to name a few), the trade war remains an ongoing hot mess which seems to have accelerated a perilous and concerning cooling of US-China relations [some have already decided it's a new cold war], ongoing massive political division, civil unrest, and the economic pressures of the pandemic. And even with that exhaustive listing I've probably missed something.
As you might guess the Economic Policy Uncertainty Index for the USA puts this clearly and quantitatively on display for us, with the May reading at the highest ever levels. Makes you wonder whether this will be reflected more directly in FX markets at some point... (but then again, to briefly argue against myself - maybe the time of maximum noise is actually a turning point and climax: one for the optimists).
Meanwhile, back on DXY technicals, the US dollar index has provided yet another opportunity for bears to get excited with the second break of that gentle, tight, upward sloping trend-channel (yet bulls will also be optimistic, for that matter, as when I last checked DXY had found support at a key level). G10 50dma breadth collapsed to what you might call oversold levels (albeit the indicator is yet to turn back up) - indicating broad weakness and bearish momentum (elevated risk of further downside).
I would say at this point downside risk is elevated given the notes on political risk, Fed balance sheet expansion, and relative performance of US vs other key developed countries especially Europe in dealing with the virus. But then again, with so many false dawns for DXY bulls and bears over the past couple of years maybe it will just be more of the same: maximum pain and confusion for both bulls and bears.
For what it's worth, we continue to maintain a high conviction medium-term bearish call on the US dollar (based on valuation, sentiment, positioning, fading yield support, political risk, expected relative performance of equities, and relative scope for economic surprise).
Until then: waiting, watching, and wondering who will win it out in the short term.
Head of Research
ORIGINAL POST (20 Feb 2020):
The US dollar index (or DXY) is on the move, but what's next and why should you care?
It's important to understand the technical forces at play that set this move up in the first place (outlined in the first chart below), because they help frame how we got here, and what might come next...
Basically the DXY is about to face a key test on the upside, and the fact is only time and price will tell whether it ends up becoming yet another bull trap, or something else. Indeed, the US dollar index continues doing an exquisite job of delivering maximum pain and confusion to maximum participants.
You might not get involved in the US dollar directly, but it plays a key role in the risk/return outlook of many other asset classes and markets, so whether you're a bull, a bear, or something else, I think you'll find these charts helpful in framing the outlook.
With that in mind, let's get on to the charts!
1. After a False Breakdown the US Dollar is Surging..
First chart, and perhaps the most important chart for understanding short-term technical dynamics for the US dollar index: this chart shows the US dollar index against 50-day moving average breadth (for G10 currencies). There's 2 things to highlight here: 1. the price action around that uptrend channel; and 2. the classical technical pattern in the breadth indicator.
On that gently up-sloping trend channel, we saw an initial attempt at breaking down, this turned out to be a false breakdown, and as is typical the subsequent rebound was swift, and now the DXY is on-watch (but I'll tell you why in a second). As for the breadth indicator, clearly in hindsight it went significantly oversold, and is now approaching overbought levels.
What to watch for: the main thing to watch for is the integrity of that gentle, gradual up-sloping trend channel. The DXY is fast approaching the upper end, and given how robust that trend channel has been so far, we shouldn't naturally expect it to break on first contact.
That is, we are about to face the opposite situation of a month ago where the DXY was making an attempt at breaking down and became significantly oversold. So I would be watching out for the DXY to encounter major resistance at the upper end of that upper trend channel as the market becomes overbought. But if it breaks out of that trend channel to the upside then we'll need to think a bit about the chart below...
2. (..and yet) US Dollar Implied Volatility Remains Near a Record Low
I'm not the only one to highlight this, but it's definitely something I've been talking about a lot (in fact it is one of what I think are the 10 key charts to watch this year). Basically, USD implied volatility remains near a record low, and the reason this is interesting is because historically a lot of major and violent moves in the US dollar index came on the heels of the same kind of profound crunch in FX volatility. In other words, low volatility is a good predictor of future higher volatility, and vice versa.
What to watch for: that's why I imply, the thing to watch for is that if the US dollar index breaks out to the upside of that so far gentle and gradual short-term uptrend channel things could get interesting (well, that is if you find massive and disruptive market moves interesting!).
But equally (and this is where it gets nuanced/complicated), if the DXY hits the upper trend line and rolls over it could just as well set it up for a big move to the downside... and that's the only issue with the volatility signal: it helps form an opinion on magnitude, but is agnostic of direction.
3. Keeping (Longer Term) Perspective
In terms of the longer term perspective, and putting this short-term trend channel into proper context, the chart below helps frame things. My first impression when I see this chart is it looks like the DXY is in the last phases of a tired-looking bull market.
The US dollar index tends to go through long-term cycles of around 15 years in duration, and I would argue we are either at or near the turning point of another one of those cycles. I'm keeping tabs on a bunch of other factors such as valuations, sentiment, cycle indicators, and monetary policy trends, not to mention the global picture. The evidence seems to stack up for the bearish medium-term take, but I would have to admit that when a market gets moving the momentum can take up a life of its own, so as a US dollar bear I am short-term nervous about that call, but unflinching medium-term.
What to watch for: the main thing to watch for with a chart like this, as I kind of alluded to, is to keep perspective on the contrasting and sometimes conflicting short-term vs medium-term dynamics playing out in this or any other asset/market for that matter.
Final Thoughts and Bottom Line
Bottom line: the DXY is on the move, but it still faces a couple of key tests that should give bulls at least passing pause for thought. Whether it passes or fails the test, the 2nd and 3rd charts provide some important historical context for what might come next.
It's always important to keep track of the outlook for the US dollar. It would be perhaps an oversimplification to say it's the only thing that matters for asset classes like commodities and emerging markets, but it's certainly a major factor. If the DXY breaks out of that uptrend channel and we see a turn up in implied volatility, it could set the stage for a sharp and disruptive move that ripples (negatively) across global markets. Though I am medium-term bullish both emerging markets and commodities, I'm wary that from a tactical perspective the US dollar is certainly a swing factor, so short-term risk management is front of mind as I update my mental models and my excel models.
For more detail on this this topic or any other specific questions get in touch...
Head of Research at Topdown Charts Limited