U.S. Dollar At A Critical Juncture

Includes: FXE, FXF, UUP
by: Eric Parnell, CFA

The reversal in the U.S. dollar has been sharp. After breaking out decisively above several key resistance levels, the U.S. dollar has fallen quickly back to earth. And now, it rests at a key inflection point. Either the U.S. dollar rallies from here, or it breaks decisively lower and returns to its old weakening ways.

A variety of fundamental reasons continue to support the idea of owning the U.S. dollar:

  1. Euro Crisis – Despite recent announcements that European policy makers are still working on delivering a plan to resolve the crisis in the coming weeks, we are still far from a solution. And important readings out of the region including Greek and Italian government bond yields suggest that the situation is continuing to get worse instead of better.
  2. Safe Haven Status - As uncertainty persists and if a crisis event were to actually unfold, the U.S. dollar stands to benefit since nearly 60% of the direction of the dollar is determined by the euro.
  3. Swiss Franc No Longer a Reliable Safe Haven Alternative – The Swiss have been successfully working for over a month now to undermine their position as a safe haven currency. And the financial problems throughout Europe may end up delivering a direct hit on banking giants UBS and Credit Suisse before its all said and done.
  4. Focus in the U.S. on Greater Fiscal and Monetary Discipline – The priority on the fiscal side is to limit new spending and cut existing spending. And while the Fed continues to tease the market with thoughts of additional stimulus, it is showing greater restraint than in the past. These are both positive developments for the U.S. dollar.

Of course, markets began signaling newfound optimism about the outlook most dramatically last Tuesday afternoon. As a result, stocks and the euro began to soar, and Treasuries and the U.S. dollar took it on the chin.

And following this recent decline, the U.S. dollar as measured by the PowerShares DB US Dollar Index Bullish ETF (NYSEARCA:UUP) finds itself sitting right on two important technical levels. The first is the 200-day moving average (blue line on chart below, click to enlarge), which had previously been resistance for the greenback since September 2010 just after Bernanke’s Jackson Hole speech. The second is the $22.00 level (orange line on chart below), which had previously served as resistance of the U.S. dollar since April 2011. Following the September breakout, both of these readings now represent support.

Thus, the U.S. dollar faces a critical test in the coming trading days. A bounce higher from these levels would bullishly suggest that the uptrend remains intact and would help build confidence around these support levels going forward. However, if the U.S. dollar continues to fall below these readings, this would be a decidedly bearish indicator that the U.S. dollar is set to continue languishing for the coming months. The next few trading days will be critically important to watch on this front in determining the outcome.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.