U.S. DOLLAR INDEX IS NEARING POTENTIAL MAJOR SUPPORT NEAR 2016 LOWS -- ELLIOTT WAVE ANALYSIS SUGGESTS DOLLAR UPTREND IS INCOMPLETE AND MAY HAVE FURTHER TO RUN -- THAT WOULD CALL INTO QUESTION A LOT OF CURRENT INTERMARKET TRENDS
A LOT IS RIDING ON DOLLAR DIRECTION... After hitting a 14-year high at the end of 2016, the U.S. Dollar Index has lost 8% during 2017. A lot of that slide came from disappointment in the so-called Trump reflation trade which was supposed to boost the U.S. economy, bond yields, and the dollar. As well as inflation. Strength in overseas economies also boosted foreign currencies in developed and emerging countries along with their stock markets. One of the side-effects of a weak dollar is that it tends to drive global funds into foreign markets which has been the case this year. The falling dollar, however, has had positive influences on the U.S. market as well, especially large cap multinationals that derive nearly half of their revenues from foreign markets. It's been estimated that a 1% drop in the dollar translates into a one-half percent gain in earnings per share for U.S. large caps. The falling dollar has been especially good for U.S. technology stocks which derive 57% of their revenues from foreign markets. A falling dollar also boosts commodity prices which usually leads to higher inflation. That could encourage the Fed to stick to its plan for hiking rates later in the year which would benefit financial stocks. There's a lot riding on the direction of the dollar. Which brings us to Chart 1.
(click to view a live version of this chart)
Chart 1
DOLLAR INDEX IS NEARING MAJOR SUPPORT... The weekly bars in Chart 1 show the U.S. Dollar Index ($USD) in decline since the start of 2017. The chart also shows, however, that the USD is entering a potential support zone formed by previous lows formed during 2016. The potential support zone ranges from 94 (the low formed last August) to 92 (the low formed that May). The lower number is the more important of the two because it represents a 50% retracement of the 2014 to 2016 dollar rally. Also because it represents the bottom of the last major correction in the dollar. A case can be made that the 2017 decline in the dollar is nothing more than a normal correction in an ongoing uptrend. For that view to hold, however, so does the low formed during the spring of 2016. The line on top of Chart 1 show the 14-week RSI having fallen to 30 which qualities as oversold territory. This marks the first time the RSI has reached the oversold threshold since 2011 when the dollar formed its last major bottom. If nothing else, Chart 1 suggests that this year's decline in the dollar is getting overdone. It also suggests that the USD may be nearing a bottom.
ELLIOTT WAVES REMAIN POSITIVE... The monthly bars in Chart 2 show the Dollar Index forming a major "double bottom" between 2008 and 2011. The upside breakout near the end of 2014 completed that bottom (green circle). The numbers on the chart are my interpretation of a likely Elliott Wave sequence. The main point of Elliott Wave analysis is that uptrends usually take place in five waves [three upwaves (1,3,5) interrupted by two corrective waves (2 and 4)]. Each upwave also subdivides into 5 waves. The red numeral (1) marks the first upwave between 2008 and 2009. Red numeral (11) marks the end of corrective wave 2. The ensuing rally between 2011 and 2016 appears to have completed a five-wave advance of its own (green numerals). That would make the late 2016 peak the end of major wave 3 (red numeral 111). If that interpretation is correct, then the 2017 decline is corrective wave 4. And the current decline shouldn't drop below the previous wave 4 formed in spring 2016 (green arrow). That leaves room for another fifth upwave. It would take a serious drop below the 2016 low to call this bullish Elliot Wave interpretation into question. The argument for another dollar upleg is supported by traditional technical analysis. One of the ways to determine an upside objective is to triple the size of the first upleg. That would be the first upwave between 2008 and 2009 which was approximately 16 points (88 - 72). Doubling that number yielded an upside objective to 104 which was hit in 2016. A tripling of the length of the first upwave (which is normal) yields a much higher objective. That also appears to support the view that the dollar uptrend is incomplete. If that turns out to be true, a lot of current intermarket trades based on a falling dollar may be called into question.
