Is The Dollar Likely To Make A Big Move Soon?

• The primary trend in the dollar is still bullish but..
• Broad momentum measures of the dollar are negative
• Euro is caught between two possible scenarios

The US Dollar Index ($USD) has been in a trading range for several months and may be about to break out, but which way? The question is an important one because a downside breakout would more than likely trigger some additional mean reversal action in commodities, gold, emerging markets and bond market quality spreads. It would also give equities a further boost. The direction of the breakout is not an easy question to answer because the technical position is pretty mixed, but I'll try and give you some pointers anyway.

The primary trend is a bullish one until proven otherwise

Since the Index is in a confirmed bull market, has a positive long-term KST and is still above its 12-month MA, I am assuming an upside breakout. However, there is enough technical evidence on the bearish side to narrow those odds considerably. Let’s review that evidence and point out what would probably be required to tip the balance in one direction of the other.

Chart 1 illustrates the positive points I have just made, as the KST is bullish and the Index, at 95 and change, is above its 12-month MA at 95.06. Having said that, the momentum indicator is pretty overextended and has started to roll over. Neither condition is negative yet, but it clearly would not take much effort to push either of these indicators into the bearish camp.

Chart 1

Chart 2 compares the Index to its Special K. You can read about this indicator here. The main thing to bear in mind is that joint trend line breaks by the price and Special K almost always offer reliable signals of important reversals in trend. Recently the indicator traced out a small top and crossed below its MA. The MA, by the way, is a 100-day SMA smoothed by a further 100-days. This places the Special K firmly in negative territory. What we have not yet seen, is a confirmation from the Index itself, which would require a violation of the 2015 red trendline.

Chart 2

Broadening the analysis

Chart 3 compares the Index to my currency diffusion indicator (!PRDIFCUR). This series monitors a basket of cross dollar rates in a bullish trend. The arrows point up reversals in the indicator as it crosses above or below its MA. The indicator is far from perfect but does give one a good feel for when we should expect to see the Index rally or decline. The diffusion indicator has been in a bearish mode for several weeks, but so far the Dollar Index has ignored its bearish message. Since it continues to register an overbought condition the dollar is by no means out of the woods.

Chart 3

The dollar is influenced by confidence expressed in the bond market

Chart 4 shows that there is a close relationship with movements in the Index and confidence, as reflected by action in the bond pits. The series in the lower panel is a ratio between high quality and junk bond yields, the IEF to the HYG. A rising ratio indicates that investors are cautious because they are favoring government paper over high yield and vice versa. Most of the time these two series move in tandem. However, there are periods, as flagged by the green and red dashed arrows, when the confidence indicator leads the Index itself. The two brown dashed arrows indicate that this relationship is not perfect as the declining confidence indicator signaled a false sense of weakness for the Index. Note that the recent dollar peak was initially signaled in advance by the ratio, which started declining in December of last year. Since July, the confidence indicator has begun to work its way higher as the Index has gone flat. Based on historic trends on the chart, this is a bullish factor for the dollar. However, it is also apparent that the ratio has fallen back to its breakout point. If that upside move turns out to be a false one it will not be good news for the dollar. That’s because false breakouts are typically followed by above-average moves in the opposite direction to the break.

Chart 4

We can see that this has already happened with a similar ratio between the Barclays 20-year Trust and the iBoxx high yield ETF, (TLT/HYG). Note that the price is right at a critical point on this Friday close chart and that the latest plot was made on Thursday and thus is not valid. However, weakness on Friday, October 9 would result in an official weekly breakdown.

Chart 5

Considering the USDU

Finally, let’s zero in on the trading range itself. Chart 6 compares the US Dollar Index to a relatively new dollar-based ETF, the Wisdom Tree Bloomberg US Dollar Bullish Fund, the USDU. Normally when we consider ETF’s the PowerShares DB US Dollar Index fund, the UUP is used because of its high liquidity. However, both the Dollar Index itself and the fund, which seeks to replicate it, suffer from what I believe is an important defect. That lies in the fact that the euro has close to a 58% weighting in the Index. Consequently, it dominates the fund, which really becomes a watered down “inverse” euro. The USDU, on the other hand, correctly gives the euro a high weight, but it is 26% less at 32%. The USDU also includes Mexico (10%), Australia (6%) China (3) and S. Korea (3). In addition Japan (19%) moves up from a 14% to 19% weighting and Canada (12%) from a 10% UUP weighting in the UUP. In other words, even though the USDU is less liquid, it is a much more diversified fund. Therefore, it tracks the dollar’s overall performance better. Back to the charts in question, we can see that both series are caught between two converging trendlines. Those lines for the USDU are far more impressive because they are longer and have been touched or approached on more occasions. An upside break would develop at 97.50 and a downside one with a daily close under.

On the other hand, it looks very much as if the USDU could be in the process of tracing out an inverse head and shoulders pattern, the completion of which would need a move above $29. Today’s action has pushed the price below the 5-month up trendline. If that turns into a more decisive break it will signal that the head and shoulders will not work and that we should expect to see a nasty move to the downside.

Chart 6

Chart 7 offers some conflicting evidence in that the intraday price of USDU has not yet violated the uptrend line, neither has it crossed below its (red) 200-day MA. On the other hand, the KST has just triggered a marginal sell signal by tentatively moving below its 10-day MA.

The overall picture I get from all these charts is that the dollar is very close to signaling a primary bear market and that any additional serious weakness will take it there. If you are looking for reference points on the Dollar Index itself, why not use a decisive daily close above 97.50 on the upside or below 93 on the downside.

Chart 7

The Euro

The Euro ($XEU) itself is in a very complex short/intermediate technical position. On the one hand, the two converging green lines may represent an ascending right-angled triangle, the completion of which would occur with a break above the 115 level. On the other hand, you can see two false breaks above the upper solid and the dashed green trendlines. If they are confirmed with a break below the dashed red line that would confirm the false breaks thereby indicating substantially lower prices.

Chart 8

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.