DOLLAR NEARS OVERHEAD RESISTANCE ZONE AS EURO NEARS POTENTIAL SUPPORT -- EURO DROP HAS WIPED OUT EUROPEAN GAINS FOR AMERICAN INVESTORS -- US BOND YIELDS FALL ON WEAKER EUROPE

DOLLAR IS STILL IN RALLY PHASE OFF 1995 LOW... Near the start of 2005, I showed a monthly chart of the Dollar Index similar to the one shown in Chart 1. The point of the earlier chart was to warn dollar bears that the USD was nearing a major support area near 80 which was its 1995 bear market low. The USD was also in a long-term oversold area as shown by its 9-month RSI line trading under 30. I wrote at the time that that the Dollar Index could rally back to its early 2004 highs in the 90-92 zone without disturbing its long-term downtrend. The USD is moving closer to that potential resistance zone. Its monthly RSI line hasn't reached overbought territory yet, but its weekly RSI has as shown in Chart 2.

Chart 1

Chart 2

DOLLAR NEARS FIRST RESISTANCE ZONE ... The weekly bars in Chart 2 show that the Dollar Index has reached 89 which puts it within 1-3% of its 2004 peaks ranging from 90 to 92. That means that the USD is nearing the first significant test of long-term resistance. The 9-week RSI line, which was oversold (under 30) at the end of 2004 (green circle), has now risen over 70 which puts it in overbought territory (red circle). There's no convincing sign that the dollar rally has ended. But dollar bulls might want to be more careful as the dollar nears that potential resistance zone. One way to do that is to track the short-term trend on the daily chart. Chart 3 (plotted through Monday) shows that the USD has been trading over its (dashed) 20-day average since early May. A decisive close under that rising support line might be an early warning sign. The daily MACD lines have already turned negative for the first time in two months. That bears watching as well. Most of the recent dollar strength has come from a falling Euro. The sharp fall in the Euro this year has wiped out strong gains in European markets when translated back into dollars.

Chart 3

EUROPE'S STOCKS GAINS WIPED OUT BY FALLING EURO... Europe has been one of the world's strongest stock market regions during 2005. When measured in local currencies, Europe has gained over 7% so far this year. That puts it well ahead of Asia (+1%) and North America (.05%). Unfortunately, that hasn't benefited American investors. That's because the dollar has been rising and the Euro has been falling. When European stock profits are exchanged back into dollars, the 7% European gain becomes a loss of -2.5% for American investors. That's why currency trends are so important in foreign investing. Compare the German DAX in Chart 4 (quoted in Euros) to the Germany iShares (quoted in dollars) in Chart 5. While the DAX has reached a multi-year high and gained 7.8% for the year, the Germany iShares have fallen by -3.8% during 2005. That's a difference of 11%. That 11% swing is accounted for by an 11% drop in the Euro since the start of the year.

Chart 4

Chart 5

Chart 6

EURO NEARS POTENTIAL SUPPORT ZONE... Chart 6 shows the 11% drop in the Euro since the start of the year which is a mirror image of the Dollar Index chart shown in Chart 2. And just as the USD is nearing a potential resistance zone, the Euro is nearing a potential support zone ranging from 120-118, which were the early 2004 lows. The oscillator is a 200-day version of the Commodity Channel Index (CCI) which is useful for spotting long-term overbought and oversold regions. The CCI for the Euro is in oversold territory. What the Euro (and the dollar) do from here has important implications for several markets. A dollar peak would be bullish for gold, oil, and other commodity markets which have already started to rally. A Euro bottom would make European stock markets more attractive for American investors. The fact that European ETFs (like the EWG) are starting to bounce off their 200-day lines may be hinting at a Euro bottom. I don't think we're there yet. But we might be getting close.

BOND YIELDS FALL ON EUROPEAN WEAKNESS... There's been a lot of discussion as to why U.S. bond yields have stayed so low. Part of the reason has to do with the fact that global interest rates are so low. That's because global economies are weaker than the U.S. Today's big drop in U.S. bond yields is directly tied to the day's events in Europe. The Swedish central bank lowered rates by 50 basis points and there are rumors that the European central bank is getting ready to lower rates to boost European economies. That pushed Euro bond yields sharply lower today (and bond prices higher) which has spilled over to U.S. bonds. Chart 7 shows the 10-year T-note yield falling back from its 50-day average. Chart 8 shows the 7-10 year T-bond iShares (IEF) bouncing off their 50-day line. The fact that the Fed has been raising rates (while Europe hasn't) is one of the reasons the dollar has been rallying against the Euro. The question is how much of the recent interest rates moves (or proposed rate moves) is already discounted in the dollar rally and the Euro drop.

Chart 7

Chart 8