The Dollar Index is setting the stage for a rally after falling to its lowest level since mid-June as traders position themselves for a stronger currency.
The measure, which IntercontinentalExchange Inc. (ICE) uses to monitor the greenback against the currencies of six major U.S. trading partners, has tumbled 4.4 percent to 81.156 from last month’s high of 84.753 on July 9. The losses have slowed, and trading patterns show any close above 82.41 would pave the way for further gains, according to Bank of America Corp.
“The market has dictated the 82.41 level as a pivot,” MacNeil Curry, New York-based chief rates and currencies technical strategist at Bank of America’s Merrill Lynch unit, said yesterday in a telephone interview. “If we get back above that, it would be a good sign that we have a base in place and a larger bull trend can resume.”
After surging as much as 5.9 percent during the first five months of the year, America’s currency has been on a roller-coaster ride as traders respond to mixed messages from the Federal Reserve on when it may begin to reduce its extraordinary stimulus. The central bank has been printing dollars to buy $85 billion of bonds every month, with the extra supply weighing on the greenback.
Fed Chairman Ben S. Bernanke said on June 19 that officials may start dialing down their unprecedented bond-buying program this year and end it entirely in mid-2014 if the labor market showed sustained improvement. He then said on July 10 that the U.S. central bank would maintain a “highly accommodative monetary policy for the foreseeable future.”
After soaring to 84.498 on May 23, the Dollar Index fell to as low as 80.498 on June 19 before rising to July’s high. It has been in a range of 81.239 to 82.494 in the 12 trading days through yesterday. That’s significant because the index has held key “support” levels at 81.40 and 81.57, according to Bank of America, making 82.41 more important.
For all the hand-wringing over Fed policy, the economy is showing signs of strength. U.S. gross domestic product will expand 2.7 percent next year, according to the median forecast of 79 economists surveyed by Bloomberg. That compares with an average estimate of 1.9 percent for the Group of 10 nations.
Options traders are bullishly positioned on the dollar, paying a premium to buy the currency versus all 16 of its major counterparts except the yen. The one-year, euro-dollar risk-reversal rate was at 1.79 percent yesterday, exceeding the average of 1.59 percent that investors have paid in 2013.
The euro, which comprises 58 percent of the Dollar Index, is creating a so-called diamond-top pattern versus the greenback, implying an imminent reversal following a 3.6 percent gain over the past month.
A diamond-top pattern occurs when an asset rallies and pulls back several times in a movement that widens and then narrows again. It signifies instability or a widening in volatility, which often coincides with a change in trend.
“That pattern says that the rally we’ve seen in euro is complete and that we’ll reverse lower,” Bank of America’s Curry said. “All the weakness that we’ve seen in the dollar versus the euro has been very impulsive. I maintain a bullish dollar bias.”
The Dollar Index may test 83.96, its highest level since July 10, if it can break through resistance at 82.68, according to JPMorgan Chase & Co. That level represents the 38.2 percent Fibonacci retracement of the gauge’s July range.
A move up through resistance at 83.93 may result in an increase to 84.75, the Dollar Index’s July high and the strongest level since July 6, 2010. It fell 0.5 percent on Aug. 2, the most since July 16, as a government report showed employers added 162,000 workers in July, fewer than economists forecast and the smallest increase in four months.
“The response to Friday’s payrolls was a little more negative than expected, and that’s weighed on price action,” Niall O’Connor, a New York-based technical analyst at JPMorgan, said yesterday in a telephone interview. “But in the medium-term, the big target will be the high we saw back in July. That will be a really big area to watch.”
Fibonacci analysis, based on the work of 13th century mathematician Leonardo of Pisa, is founded on the theory that prices rise or fall by certain percentages after reaching a new high or low. Resistance refers to an area on a chart where sell orders may be gathered, and support is an area where there may be buy orders.
The dollar is the third-best performer this year after the euro and Sweden’s krona, according to Bloomberg Correlation Weighted Indexes that track 10 major currencies. The greenback gained 4.2 percent, the krona rose 4.3 percent and the euro strengthened 5.6 percent. The yen is the second-biggest loser, sliding 7.2 percent.
The Dollar Index’s ability to close above key moving averages will be important in re-establishing a bullish trend, according to ING Group NV. The gauge’s 200-day moving average was 81.576 yesterday, while its 50-day average was 82.352.
“A close above the 200-day moving average line would confirm the successful test of horizontal support,” Roelof-Jan Van den Akker, an Amsterdam-based technical analyst at ING, said yesterday in a telephone interview. “A close above the 50-day moving average line definitely confirms that we’ve seen a bottom, and that the next rally is underway to 83.20 and possibly higher.”
Chart: FXStreet Flash Chart - Teletrader software AG