The USD/JPY tested its 1998 highs marked by the Asian Financial Crisis. The British pound revisited its all-time lows. And the euro fell below parity versus the US dollar for the first time in twenty years.
But where does that leave the King Dollar heading into Q1 2023 now that it has fallen almost 10% off its September peak and many global currencies have reclaimed key levels?
Let’s turn to the charts for some answers…
First, take a look at the US dollar index $DXY:
The dollar index is reaching a crucial level marked by the 2016 and 2020 highs – a logical spot for it to bounce. Honestly, I’d be surprised if it doesn’t!
Yet, the DXY seems stuck in the mud. That’s information.
Here’s a look at the daily chart:
Momentum stands out as the US dollar index arguably broke down from a bullish momentum regime but failed to register oversold conditions. The lack of an oversold reading reveals the bears’ inability to take control.
Regardless, it broke the parabolic advance from the May 2021 lows. As long as it holds below a key retracement level of 105.25, the path of least resistance remains lower.
But the absence of a bearish momentum reading and the potential polarity zone marked by the shelf of former highs has us raising our eyebrows at the very least.
It would not only make sense to see a bounce off those former highs, but a period of digestion after the recent sell-off in the DXY would be a healthy development.
Also, when we look beneath the surface at our USD A/D line, it’s far more buoyant than the DXY and our G-10 currency index:
The hardest hit currencies – mainly developed Europe – are snapping back after steep sell-offs earlier in the year. Remember, the pound retested its all-time lows! Our G-10 index and the DXY reflect those forceful mean reversions.
But the more resilient currencies during this year’s USD rally, especially the commodity currencies, continue to chop sideways. The triple pane chart of the Aussie, Kiwi, and Canadian dollars tells the story as they attempt to take back their July pivot lows:
As I pointed out last month, I don’t imagine a meaningful downtrend in the dollar materializes until these three commodity currencies get on the same page.
My point of view hasn’t changed, and neither has the lack of confirmation from these currencies.
It’s simple: risk-on currencies such as the AUD, CAD, and NZD need to reclaim their summer pivot lows and trend higher, indicating broad dollar weakness. While I continue to stand by this theory, the next chart carries the most weight…
Check out the weekly chart of the EUR/USD:
If the euro bulls aren’t happy, nobody’s happy!
The euro constitutes more than half of the dollar index. And the fact it ripped back above a crucial shelf of former lows at approximately 1.0350 with ease was a nail in the coffin for the US dollar rally. Now the former resistance level represents potential support.
Here’s a closer look at key levels of interest on the daily chart:
Unlike the DXY, the EUR/USD has broken out of its former momentum regime and posted an overbought reading. Momentum supports a bearish to bullish reversal in the underlying trend.
Nevertheless, the euro approaches a potential resistance zone of 1.08. Range-bound action between the June and August pivot highs (1.08 - 1.0350) seems reasonable.
So what does it all mean for risk assets, particularly equities?
If the EUR/USD trades below 1.0350, stocks and commodities alike experience increased selling pressure. On the flip side, I think risk assets will benefit from either a falling dollar or a lack of volatility in the FX markets.
In the event the euro chops above 1.0350 and the DXY experiences a mild counter-trend rally, stocks will likely continue to base. Nothing wrong with that…
I can’t think of a better scenario after this year’s sell-off. The major stock market indexes need to repair, particularly the S&P 500 and Nasdaq 100. And when we review intermarket relationships between emerging market currencies and US stocks, they paint a constructive picture for equities.
Notice the Chinese yuan and the S&P 500 $SPY have a strong tendency to peak and trough in unison.
The yuan bottomed in early November and has trended higher since. The question is whether the US dollar will follow.
The Thai baht presents a similar picture:
I don’t know if or why the baht carries any inherent insight. I simply use it as a proxy for emerging market currencies. And when I overlay the charts, the baht is reclaiming a key level that has marked major bottoms in the past (‘09 and ‘16) for the S&P 500.
Perhaps these charts have more to do with the US dollar than the Chinese yuan or Thai baht. That could very well be true. Regardless, the S&P 500 seems to like it when these emerging market currencies reclaim key levels and catch higher.
The bottom line is that there will be plenty of opportunities in early January, regardless of the asset class and despite the sideways chop.
Now is the time to monitor the markets for risk/reward opportunities heavily skewed in our favor. When institutional investors return from their holiday, structural trends will likely take shape.
