From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
While most uptrends have come under pressure in 2022, the US dollar has remained as strong as any.
This dollar strength, particularly at the index level, is nothing new. We've been discussing it.
It's been taking place all year, driven by the major pairs such as the euro, the yen, and the pound.
However, something new is the burgeoning strength beneath the surface, even outside of the big developed market currencies. We've been seeing dollar internals improve drastically in recent weeks.
And now we're seeing momentum accelerate for the US Dollar Index $DXY. Today, DXY is on track for its largest single-day gain since the pandemic crash more than two years ago.
All of the evidence suggests this dollar strength is the real deal.
Let's talk about what it means and how we want to position for it.
Here's the US Dollar Index ripping to its highest level in almost 20 years:
Momentum is registering its highest reading since 2015, confirming the breakout to new highs.
One thing that had us questioning the dollar rally earlier in the year was the resilience from non-DXY currencies. Outside of the main DXY components, the price action wasn't nearly as bullish for the dollar.
That all changed recently and the divergence in our broad dollar index has cleared itself up. Now our G-10 index is confirming the new highs from DXY:
When we take an even more comprehensive view of the US dollar's health and look at our custom advance-decline line, it's the same story:
Our dollar A/D line is comprised of 29 currencies. This gives us a very broad measure of how USD is faring against its peers. Seeing new highs in this indicator is solid confirmation of the recent rally in DXY.
All of this evidence is illustrating the same thing: The US dollar is firing on all cylinders right now.
One way we can invest in this theme is by shorting the euro. We've already been short EUR/USD, but it recently achieved our objective.
Here's a long-term view of the weekly chart:
Just like DXY is breaking out from a roughly seven-year range, the euro appears to be breaking down from a similar rectangle pattern. Momentum is hitting its lowest level since 2015, which supports a downside resolution.
This is a massive continuation pattern and it's coming on the heels of a decade-long top. The opposite is true for DXY. It's resolving higher from a continuation pattern following the base breakout and rally from 2014-15.
In other words, the primary trend is up for DXY and down for euro.
While we want to be patient and allow for some short-term backing and filling at these former lows, we can use EUR/USD as a vehicle to bet on continued dollar strength if and when we get a valid downside resolution.
We're short on weakness below 1.04 with a long-term measured move target of 0.83. This is a long-term setup so we're looking out about one year or more for this target.
As for what this structural breakout in the dollar means for risk assets, this chart tells us everything we need to know:
When the dollar is rallying, international stocks tend to be falling. When the dollar is falling, international stocks are typically in an uptrend.
In the lower pane, you can see just how strong of an inverse correlation the Emerging Markets Index $EEM has with the US Dollar Index. This historical correlation has held through the test of time and is not one we want to bet against.
The recent action from the DXY is bearish for the stock market. If the DXY were to cool off or roll over, it would be a tailwind for stocks. But for now, all this strength is putting pressure on stocks in both the US and abroad.
Can this relationship diverge from time to time? Of course.
In fact, the DXY's historic inverse correlation with commodities has been diverging for several quarters now as both are rallying together.
This will happen every now and then, but it doesn't mean it's sustainable. In the case of commodities and the DXY, one is bound to catch lower.
And considering the burgeoning strength from the USD, it doesn't look like the dollar will be the one to falter.
Now that stocks have fallen victim to a strong dollar, are commodities next?
