From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
The US Dollar Index $DXY has been a good reminder that price doesn’t always move in a straight line.
Paul Tudor Jones has been quoted saying “markets only trend about 15% of the time.” The textbooks will tell you it’s somewhere between 20% and 30%. But it all comes down to how you’re measuring it.
We think it’s fair to say most markets trend about 25% of the time on a structural basis.
And the present year two market conditions have been a great illustration of what they look like the other 75% of the time… range-bound... sideways... a hot mess.
Speaking of which, last week, we pointed out that Dollar strength had stalled and that things were beginning to look messy on shorter time frames.
Many of the long USD trade setups we laid out in late June have yet to break out and are currently testing their respective risk levels, with the lone exception of the AUD/USD.
Mixed signals and indecision remain the case for the Dollar as DXY attempts to find its footing and take out the upper bounds of its year-to-date range... again.
Given the far-reaching impact the Dollar can have on risk assets around the globe, let’s take a step back, discuss the recent price action, and identify some critical levels of interest.
First up is a daily chart of the US Dollar Index:
Like much of the broader market, the Dollar Index has been range-bound since the beginning of the year. Though this range may be frustrating for a trend-following approach, at least it's providing us with some well-defined support and resistance zones.
The crucial levels in DXY are the March/July highs around 93.20-93.30 and the January/May lows around 89.40-89.60.
It’s very simple. The path of least resistance is higher if price breaks and holds above 93.30. In this case, the dollar would act as a headwind and most likely put some pressure on stocks and commodities.
On the flip side, if sellers defend these former highs and send prices back toward the lower bounds of this consolidation, it would be a tailwind and put a further bid in risk assets.
These are critical levels that demand our attention. They don't just provide information on the potential direction of the US Dollar, but also insights around the impact it's likely to have on other assets.
So, which potential outcome is most likely, based on the weight of evidence?
First of all, there’s a pretty ugly potential momentum divergence in play. Even while DXY is pressing toward its highest level since March, the daily RSI-14 hasn’t been able to register an overbought reading for over a month.
But not only is momentum waning, breadth is also deteriorating beneath the surface when we look at individual Dollar crosses.
Here’s a look at our USD trend summary table:
At first glance, the outlook is mixed on both short and long-term timeframes. But, when we compare it to what the table looked like just two weeks ago, there are some stark changes.
The most significant difference was an uptick in bearish percentage on a short-term basis, from 0.00% two weeks ago to 26.67% today.
We also saw the percentage of bullish short-term trends move down, from 80% to 60% for the USD.
So, despite the DXY just barely eclipsing its highs from two weeks ago in recent sessions, the Dollar is actually performing worse relative to other currencies than it was back then.
That’s another potential bearish divergence we have our eyes on right now.
Much of the reason for this can be attributed to the approximately 60% weighting toward the Euro in the Dollar Index and the near-term weakness in EUR/USD.
Here’s the index’s breakdown by currency:
So, what’s the takeaway?
The shift away from extreme bullish readings on shorter time frames highlights waning Dollar strength and indecision. It suggests we want to be very cautious about, and even a bit skeptical, of these new highs in the DXY.
If the Dollar couldn’t break through its year-to-date highs last month when participation was much stronger among its individual pairs, why should we think it’s going to get it done this time around?
Either way, the DXY is currently testing a critical area of former resistance.
While signals are mixed, and these fresh highs are certainly lacking confirmation, at the end of the day price is what pays. And, while we can argue that much of this is being driven by the Euro, we can also argue that’s just fine because the Euro is a very important currency for global markets.
This all points to practicing patience, sticking to our plan, and managing risk at every turn.
We don’t have a crystal ball, and there’s no rule saying price can’t break out and work these divergences off over time.
For now, we simply want to pay attention to and respect our risk levels. Whether the DXY breaks out here or fails, it’s going to have wide-ranging implications for risk assets.
