A little more than a month ago, we began to see broad-based strength in USD emerge on both a short and intermediate-term basis.
Since then, it’s been the central theme in currency markets.
But we're starting to see signs that this near-term US dollar dominance could be fading as bulls have had ample opportunity to push the USD higher in recent months but have made little progress.
The lack of follow-through can be seen in our long USD trade ideas from late June, as most are not working. We recently saw many crosses reach our risk level, but price rebounded instead of triggering an entry. The EUR/USD is a great example of this.
One exception is AUD/USD, which is working in favor of the dollar. The Aussie is also continuing with its series of lower highs and lower lows relative to the Yen. Both of these pairs are actually suggesting a risk-off tone for global markets.
Now let's zoom out and put the recent USD price action into the context of our structural outlook.
We continue to hold our longer-term view that the US dollar is forming a 6-year double top, so it makes sense to see this weakness:
But over shorter time frames, things are beginning to look messy as plenty of pairs are stalling out or transitioning to a more neutral or sideways trend.
Let’s look at a couple of charts highlighting the indecision and potential weakness coming down the pipe for the US dollar.
And most importantly, we’ll discuss the implications this could have on the broader market.
First up is a monthly chart of the USD/MXN:
Two things stand out in this chart.
First, an 8-year trend line was violated earlier this year. This is often one of the earlier signals we get that suggests a potential bullish-to-bearish trend reversal is underway.
The violated trend line fits our longer-term bearish outlook for the dollar and speaks to potential structural weakness.
Second, we have had two months of price action depicted by Doji candlesticks since the trend line violation.
Dojis represent indecision as market participants push prices higher and lower only to settle right back where they started. No real progress from either side.
For the past two months, price hasn’t gone anywhere in USD/MXN. It has just chopped around like many market areas, pointing out the lack of conviction from both bulls and bears.
And this action makes plenty of sense. It’s a mess out there, remember?
So why does the direction of the USD matter to those who don’t trade forex or currency futures markets?
This next chart answers that question pretty well:
This is the USD/MXN overlaid with the S&P 500. If you can’t see the inverse relationship just by looking at price, we’ve illustrated it with a correlation coefficient in the lower pane.
The USD/MXN and the S&P 500 have a very strong inverse correlation. And it’s remained steadily intact since the Covid sell-off last year.
This speaks more to how the direction of the US dollar can impact risk assets than the intermarket importance of the Mexican Peso.
In other words, if we charted the USD vs. plenty of other “risk” currencies, you’d see a similar picture.
But the USD/MXN serves our purpose for today as it tells this story well.
A weakening dollar can act as a tailwind for stocks and commodities. On the flip side, USD strength can act as a headwind.
If investors aren’t seeking safety in the US Dollar, which seems to be the case in the near term as the dollar can’t seem to catch a bid... What does that mean for stocks and commodities?
It probably means they’re doing pretty well, as a dollar that’s no longer rising should alleviate some of the selling pressure for risk assets.
The bottom line is whether you’re trading these markets or not, what happens in currency land matters for the bigger picture. Crosses like USD/MXN and others are full of valuable information, and the price action in them can offer us a nice read on how other major asset classes around the world are likely faring.
