Will EM Currencies Rip as the Dollar Dips?

From the Desk of Ian Culley @IanCulley

The US Dollar Index $DXY is dropping – and our bearish USD trade ideas are beginning to trigger.

While I tend to stick to major developed-market (DM) currencies for placing trades, I still monitor the less liquid forex pairs for information. 

I want to see DM currency strength spill over into emerging-market (EM) currencies, confirming the broadening US dollar weakness. 

As always, I strive to break it down to one level, one chart, whenever possible. 

This next chart does the job…

Here’s the WisdomTree Emerging Currency Fund ETF $CEW:

CEW is carving out a possible reversal pattern below a polarity zone, coinciding with a series of key pivot highs and lows from 2021 and 2022. 

Notice momentum has improved as price churns below resistance. This supports a potential upside resolution.

My view turns higher for EM currencies on a decisive close above 18.00. A breakout above that level also implies a significant tailwind for global risk assets – stocks and commodities – and confirms the bullish price action from DM currencies.

For me, it’s all about confirmation via broadening participation from global currencies. And broadening participation is exactly what we see when we look beneath the surface of CEW.

Check out the percentage of CEW components trading above their 50-day moving averages (lower pane):

More than half of the components trade above their respective averages, revealing an explosive breadth improvement since early March. Increased upside participation among EM currencies supports a sustainable uptrend for the CEW ETF.

Our euro trade is working. The pound is catching higher after flashing a buy signal. And the Canadian dollar and the Japanese yen aren’t far behind. It makes sense, given the slumping DXY. 

But the chance of these trades reaching our upside objectives improves in an environment where CEW posts fresh 52-week highs.

A US dollar rally doesn’t have much chance if the euro trades above 1.08. Which it does!

On the flip side, I can’t imagine a sustained USD decline as long as CEW holds below 18.

Sometimes, it’s that simple!

Stay tuned!

Thanks for reading.

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