DOLLAR IS UP AGAINST RESISTANCE AT SPRING 2004 HIGHS AND IS OVERBOUGHT -- INTEREST RATE DIFFERENTIALS MAY START SHIFTING AGAINST THE DOLLAR
MONTHLY DOLLAR INDEX CHART ... To get a better idea of where the dollar stands in relation to its long-term trend, it's a good idea to start with the monthly chart. The monthly bars in Chart 1 show the Dollar Index peaking at the start of 2002 and falling for the next three years. That was due to the Fed's aggressive lowering of short-term rates to combat a recession and fears of deflation. At the start of 2005, however, the USD bounced off long-term chart support near 80 which was the low formed during 1995 (green line). That was largely due to the Fed's raising rates starting in mid-2004. It's been rising since then, but not by that much. So far the USD has recovered only 30% of its previous downtrend which is well within the confines of a normal retracement. In addition, it's reached the first resistance barrier formed in the spring of 2004 (red line). That's the first major hurdle that the Dollar Index needs to overcome if it's going to continue its rebound and make a case for a major bottom being formed. The weekly bars in Chart 2 give a closer look at the current situation.
Chart 1
DOLLAR UP AGAINST RESISTANCE ... The weekly bars in Chart 2 give a closer look at the U.S. Dollar Index testing its spring 2004 high just above 92 (horizontal line) . That's a pretty formidable chart barrier, especially considering that the USD has completed a five-wave advance since the start of 2005 and is giving some negative divergences. The 9-week RSI line along the top of Chart 2 is backing off from overbought territory at 70 and is lower than the previous peak hit over the summer (blue arrow). That's a negative divergence. The weekly MACD lines beneath the chart are positive, but have yet to reach a new high with the price action (red arrow). That's another negative divergence. Negative divergences in the fifth wave of a market advance usually carry the most significance and the biggest warnings. That's especially true when the market in question has also reached an important resistance barrier as is the case with the dollar.
Chart 2
SHORT-TERM LOOK AT THE DOLLAR ... The daily bars in Chart 3 show the more recent dollar trend through yesterday. Although no serious selling has been seen so far, the daily stochastic lines along the top are turning down from overbought territory. The 12 day Rate of Change (ROC) line along the bottom is also starting to weaken. That suggests that the dollar uptrend may be losing momentum as it tests major resistance just over 92. What could cause that to happen? It all comes down to interest rates. Over the last year, the Fed has been raising short-term rates while the rest of the world hasn't. That has boosted the dollar relative to foreign currencies like the Euro and the yen. The spread between high U.S. rates and low foreign rates needs to narrow for the dollar to weaken. Last week the president of the European central bank stated that Europe is ready to raise rates for the first time in five years. That hike in European rates is expected during December. A few weeks back the Japanese central bank predicted the end of deflation in that country and hinted at higher Japanese rates in 2006. Yesterday's release of the Fed's November meeting hinted at a possible end to U.S. rate hikes. If that's the case, the spring of 2006 could see U.S. short-term rates leveling off while foreign rates are rising. That would be negative for the dollar.
Chart 3
DOLLAR WEAKNESS COULD HELP COMMODITIES... Although the link between the dollar and commodity prices hasn't been that strong over the last year (both have risen together), the two markets have moved in opposite directions since the start of September which is their usual pattern (Chart 4). Yesterday I showed the CRB Index (and crude oil) bouncing off their 200-day moving averages. Any significant pullback in the dollar could give a boost to commodity markets which are near chart support. Gold, which has been rallying along with the dollar, is nearing a major test of its own.
Chart 4
GOLD NEARS TEST OF $500 ... The major trend of the dollar has, in the past, had a major impact on the major trend of gold. Chart 5 shows that the Dollar Index (green line) and gold normally trend in opposite directions. The dollar peak in 1984 helped launch a major gold rally. The dollar bottom in 1996 resulted in big gold declines. They sometimes trend together for short periods of time, but eventually return to their normal inverse relationship. The dollar peak at the start of 2002 launched the latest bull market in gold. Over the last three months, however, both markets have been rallying together. That's not likely to last. I suspect that one of them is due for a fall in the not too distant future. Although I remain bullish on the long-term trend of gold, I'm somewhat nervous as it approaches major chart resistance around $500. Gold may run into some profit-taking as it approaches that chart and psychological resistance barrier. A dollar pullback from current levels could help soften the impact of any gold selling.
Chart 5
HAPPY THANKSGIVING ... The week of Thanksgiving is usually a good one for the market which may explain today's move into new high ground. The day after Thanksgiving is usually a positive day as well. That's something to be thankful for. Along with a lot of other things. Happy Thanksgiving.
