The attempted upside breakout by the US dollar index has the potential to change the path of markets this year, so in this article, we take a longer-term perspective on the US Dollar Index (DXY). The chart in focus for this article can be pointed to by both bulls and bears to state their case; the bulls would say this is a repeat of the 1998 correction-and-continuation, and bears would say ‘it’s different this time’. In either case, it’s worth putting the short-term action into context of the longer-term picture.
Today’s chart comes from an exclusive report on the US Dollar Outlook, where we shifted to the neutral camp from a previous bearish bias – respectful of the breakout, but skeptical.
The chart below shows that the US Dollar Index is trading above its 10-year/long-term moving average, which indicates that the USD has strengthened against its major trading partners recently, but as alluded to earlier, there is reason to be skeptical of the DXY bull case.
Specifically, the chart shows a longer-term perspective by comparing the US Dollar Index against the 10-year moving average and long-term average blend. Also shown are the standard deviation bands (i.e., one standard deviation above and below the long-term average) which helps bring into focus the cycles and ranges of the US Dollar Index.
Typically, when an index breaks its resistance level, it sounds a bullish alarm which is one of the reasons why investors pay it so much attention. But history is filled with many examples of false breakouts. Another point which typically supports the bull case is recently there has also been a slight rebound in the 10-year/long-term moving average, as seen on the chart, which indicates momentum in the US Dollar Index. It’s all the more interesting when you consider how low US dollar volatility has been.
As the EUR/USD is a major part of the US Dollar Index, keeping on top of the picture in Europe is critical in putting the larger puzzle together. The April Europe manufacturing PMI showed a slight rebound at 47.9%, and with sentiment on Europe distinctly pessimistic at the moment, it can be argued that Europe has clear scope to surprise to the upside. Indeed, the Eurozone economic surprise index has already made a clear turn to the upside after becoming stretched to the downside.
Another important point regarding the EUR/USD comes from a key chart we talked about in the DXY outlook report, which shows the EUR/USD as being undervalued and a crowded short. What’s more, the latest ECB bank lending survey seems to be pointing to a rebound in GDP growth in Q2. So while the consensus favours a weaker Euro, we’re not convinced.
Back in the USA, growth has softened and a combination of negative news flow and market volatility have side-lined the Fed rate hikes (Fed tightening was a key argument to be bullish USD), and quantitative tightening *tapering* has now begun with the Fed running down treasury holdings by only $15B max per month vs. the previous $30B.
So, with the EUR/USD undervalued and a crowded short, a slight rebound in European PMI, arguably greater scope for upside surprise compared to the US, and a possible rebound in Q2 GDP, the Euro does not seem like an obvious short to us. With the EUR/USD making up a significant portion of the US Dollar Index, this adds to the skepticism of the DXY bull case.