Dollar Strengthens On Weak Euro

Aug.21.14 | About: PowerShares DB (UUP)

Summary

The dollar is up 3.19% since the first week in July.

The euro is down 3% since the first week in July.

The start of QE in the ECB and the end of QE in America will have a positive effect on the dollar.

The dollar reached an 11-month high on two very positive days on 8/19 and 8/20, respectively. While the Dollar Index is at its highest level since September 2013, the euro broke the 1.33 level for the first time since that same time. Since the first week of July, the dollar is up 3.19%, while the euro is down a little over 3%. The charts below show the action in the euro on both a long-term and short-term timeframe. The long-term chart shows a solid resistance level that has held since 2007, most recently hitting 1.3524 and reversing. The shorter-term chart shows we have broken through the 1.3479 support level that has been in place since January 2012.

Long-Term Euro Chart

Source: Bloomberg 8/21/2014

Short-Term Euro Chart

Source: Bloomberg 8/21/2014

Central bankers from around the world have descended on Jackson Hole, WY for the Kansas City Fed Symposium this week. Since European Central Bank (ECB) and US Fed policies are on the agenda this week, we should get a better idea of what policies these groups are looking to continue/initiate. Janet Yellen and the US Fed are widely expected to end Quantitative Easing (QE) around October of this year, while Mario Draghi and the ECB are potentially only looking to get started with QE. In reaction, the euro has fallen nearly 3% against the dollar since the June Fed meeting. Unless outlooks change, I expect this to continue. Draghi will speak Friday (8/22), and the expectation is he will address the dangerously low 0.4% inflation rate and propose a plan to address the economic slump the 18-member strong eurozone is currently faced with.

Meanwhile, in the US, we are continuing to receive good economic numbers -- most recently manufacturing, jobs and GDP data -- giving market participants hope that the US economy is doing well. Adding to this sentiment are falling US jobless claims: we are currently experiencing the best monthly job creation streak since the 1990s. The Fed appears committed to ending QE this year, shifting focus on the real possibility of rising interest rates starting from the middle of next year. I am also looking for the strength in the dollar to continue, driven chiefly by ECB action: the devaluing of the euro by the ECB to fight disinflation has had a positive effect on the dollar so far. Looking at the chart below, we see the dollar has managed to break out of the range it has been in since the end of 2013, when it went above 81.2 on July 29th.

In terms of trading, I am looking for the dollar to outperform the euro both in the short and long term. It is important to stress that should this materialize, it will not happen in a straight line. I will use pullbacks as buying opportunities in the dollar against the euro. Traders who share this market sentiment might look at shorting the September euro contract with a target of 1.29 in mind. The contract expires on September 15th, so there is some time left for this to work. For one contract, the aforementioned target would represent a move of 3.8 cents or roughly $4,775. I suggest risking no more than $2,500 on the trade or putting a stop loss at 1.3482.

Dollar 5-Year Chart

Source: Bloomberg 8/21/2014

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