When it comes to gauging the strength of the U.S. dollar, one of the things we often focus on is the performance of the USD Index (DX). The DX is a weighted average of six foreign currencies against the U.S. dollar. Currently, the index includes the Euro, the Japanese yen, the British pound, the Canadian dollar, the Swedish krona and the Swiss franc.
On the weekly chart, the DX cleared its long term 30-year support level back in April 2006. In the same month, the breach of the Ichimoku cloud, which is designed to give support/resistance levels, trend direction, the strength of the trend and the potential entry/exit points, triggered the acceleration of a major selloff. Since then, the DX has been trading in a sharp downtrend with the 50-week simple moving average and the Ichimoku cloud hanging on top as major resistance hurdles. The Tenkan-sen, Kijun-Sen and Chikou Span are still showing no signs of major reversal at this point. However, we are seeing some recovery potential, at least in the short term. The DX is currently forming a double bottom pattern around 0.7100. The first bottom occurred in March and formed a strong bullish engulfing pattern. A week ago, while it was retesting the March low, a reversal hammer also emerged. This should give the DX some support. In addition, the MACD indicator is showing positive divergence. When the DX fell off the cliff from 0.75 to 0.71, MACD histograms were hovering around the same level, not to mention the golden crossover which occurred in May.
We are likely to see the dollar getting a lift from here. The break above 0.73 will take the DX back to the 0.75 level, which is near the 50-week moving average. The 0.75 level is extremely important because it is long term resistance. If the 0.75 level gets cleared, we will be eyeing the 0.80 level. In order for the DX to reverse trend, it has to clear the 0.8265 level, which was 30-year resistance.
Is this the real bottom for the DX? I am bullish on the dollar in medium term based on “relative strength,” especially with the British pound. The bottom line is that we still have to keep a close eye on the fundamentals. After all, fundamentals determine the real tops and bottoms in the FX market. If the Federal Reserve raises the interest rate in the fourth quarter, or even early next year as the market is currently anticipating, then a bigger dollar rally may be coming our way.
Jason Yu is the chief currency strategist with ODL Securities Inc. Forex is not suitable for all investors.
