From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
As 2022 approaches, the latest evidence from currency markets suggest the US Dollar Index $DXY could be stalling out.
Whether it resolves higher from the current continuation pattern is a key question with broad market implications. While dollar strength has been a headwind during the second half of 2021, we think it cools off coming into 2022.
In our view, there's a good chance a weaker dollar will actually help put a bid in risk assets in the near future. This hasn’t been the case in a while, so let’s discuss what’s changed to make us feel this way.
Notice the short-term weakness in our US dollar trend summary table:
The percentage of short-term bearish readings has jumped from 13.37 to 60.00 over the past two weeks. This tells us there's been a significant drop-off in the dollar’s strength versus its peers, even as the DXY coils in a tight bull flag.
Bulls want to see the dollar get stronger beneath the surface to support a resolution higher for the DXY, but it's showing weakness and suggesting this pattern is likely to fail.
An upside move in the US Dollar Index seems even less promising when you consider our Canadian dollar and Australian dollar shorts from earlier in the month failed and are now trending higher.
Today, we’ll highlight some other failed breakouts in USD versus emerging market forex pairs.
First up is the South African rand. Here's the USD/ZAR cross:
Toward the end of November, we pointed out that emerging currencies were falling against the dollar. And one of the ways we wanted to express that thesis was by buying the breakout in the USD/ZAR.
Fast-forward to today, and we have a failed breakout, as price just slipped back into its prior range after an unsuccessful attempt at holding its new 52-week highs.
This action certainly doesn’t bode well for USD strength, nor does it support a sustained rally in the dollar index. If the DXY ever resolves higher under a healthy backdrop of broadening strength versus its peer currencies, we’d expect the USD/ZAR to be back above the key 15.68 level and trending higher.
But that’s the exact opposite of what we’re seeing now. These failed moves are critical information. And this is especially true when they’re not isolated incidents, which is the case right now in the forex market. We're seeing them all over in USD crosses.
Another great example of a failed breakout is the Mexican peso. Here's the USD/MXN pair:
While the US Dollar Index and the rand have been chopping mostly sideways during the last month, the USD/MXN has been sliding lower and is back in the middle of its 12-month range.
The inability of the USD/MXN cross to hold above a key retracement level and its year-to-date highs is illustrative of the broad dollar weakness we continue to see in individual crosses.
Seeing this decisive move lower following the failed base breakout is not the type of action we’d expect in an environment where the US Dollar Index is breaking out.
The peso is not the only petrocurrency that's started to gain ground against the USD. We’re also seeing similar strength in commodity-centric currencies like the Australian and Canadian dollars.
We’ll continue to monitor this forex pair from a commodity-centric and broad USD perspective. For now, the peso hints at trouble ahead for dollar bulls.
Finally, we have the Indian rupee. Here's the USD/INR cross:
The USD/INR has been pounding the 75.80 level from below for the past two years, absorbing more overhead supply each time it does.
Like the USD/MXN, bulls just attempted to break out of this consolidation. But the attempt was short-lived, and price retreated back into its prior range.
The US dollar’s repeated failure to hold above breakout levels in recent weeks is a warning sign for those positioning for a higher dollar. If it can’t sustain new highs on an individual currency basis, why should we expect these new highs in the DXY to be any different?
When the team gathered a couple weeks ago to discuss the upcoming Q1 Playbook, the US dollar was at the top of the list. It’s certainly a surprising development: The dollar and commodities rising together?
We noted that while the US Dollar Index was consolidating in a bullish continuation pattern, the more important development was that it’s also near critical levels relative to many other world currencies.
In the short time since, the dollar has continued to weaken and has now lost many of the key levels it was holding or testing earlier in the month.
Could the USD bounce back, reclaim these levels, and resolve higher at the index level?
Absolutely! We’re just not seeing it yet…
We’ll continue to monitor the currency markets and the US dollar for crucial developments that could impact the broader market.
Be sure to check back and be on the lookout for the upcoming Q1 Playbook!
