From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
Interest rates, inflation expectations, and commodities are all on the rise.
But as these pieces of the intermarket puzzle fall into place, it’s hard to make sense of the strength in the US Dollar Index $DXY. That’s also been on the rise recently.
Even other areas of the currency market don’t quite fit with the action we see in the USD. We pointed out the absence of risk-off behavior in a post last week where we highlighted the broad weakness in the yen as well as AUD/JPY making new multi-month highs.
So what’s going on with the US Dollar Index?
Let’s look under the hood at some individual USD pairs and their trends across multiple timeframes to see what the weight of the evidence is currently suggesting.
First, let’s look at the short-, intermediate-, and long-term trends in some of the main US dollar crosses:
Our bullish trend indicators have all rolled over since the US Dollar Index hit new 52-week highs last month, with the number of USD crosses in short-term uptrends dropping by more than 50%.
The main takeaway is that, on balance, the USD is trending lower on all timeframes against the majority of its pairs. Yet the US Dollar Index remains at the upper boundary of its year-to-date range.
These trend identification metrics in the bottom three panes above can also be visualized in a table format. Here’s what that looks like:
At first glance, it sure seems like there’s a lot of red in here. How could DXY be holding up so well if this is what’s taking place beneath the surface?
The answer to that has everything to do with the composition of the index.
The US Dollar Index is bullish against only two developed currencies across all timeframes: the yen and the euro. These very same currencies comprise more than 70% of the index’s weighting. This should help explain the buoyancy in DXY of late.
The US dollar’s neutral and bearish short-term trend readings against the remaining DXY components have little impact on the index, as the euro and yen carry so much weight. But these other crosses are giving us some key information right now, which is NOT reflected in the price action at the index level.
When we step back and look at the table as a whole, it’s clear that USD strength is narrowing across the board.
Aside from the euro and the yen, the Brazilian real and Indian rupee are the only currencies the USD is trending higher against across all timeframes.
When we overlay the US Dollar Index with our broader equal-weight G-10 Ex-US Currency Index, it illustrates the skewed weighting in DXY and highlights the broad USD weakness lately:
Notice how the broader currency index has failed to make a higher high along with DXY.
It’s hard to make sense of DXY strength when commodities across the board are resolving higher, interest rates are rising worldwide, and the US dollar itself is trending lower versus so many of its peers.
But when we dig down to the individual crosses, it becomes clear that near-term USD strength is limited to just a couple key players -- and that’s making all the difference.
If it were going to break out of this range, we’d think it would have done so a few weeks ago when the USD was still in a bullish trend against 80% of currencies on each timeframe.
If it couldn’t get it done then, we shouldn’t expect it to now, as it’s presently showing significantly less strength versus individual currencies.
Unless this changes, we don’t see the dollar breaking out of this range. And that would actually make plenty of sense in light of all the risk-on developments we’re seeing elsewhere these days.
