The U.S. Dollar Index Could Be The Next Shoe To Drop

|
Includes: UDN, UUP
by: Ed Wijaranakula

Summary

The U.S. dollar index is now at risk of a major move to the downside if the technical support at the 94 level can’t hold.

The U.S. dollar index could be under selling pressure if there is no Fed rate hike at the April FOMC meeting.

EUR/USD is about to make a major breakout to the upside.

The strengthening yen could put more selling pressure on dollar.

A weak British pound sterling could provide some support to the dollar.

The U.S. dollar index, or DXY, a weighted index of the value of the U.S. dollar relative to a basket of six major currencies, has been falling off the cliff since the Bank of Japan, or BOJ, said in late January that they would introduce quantitative and qualitative monetary easing and apply a negative 0.1% interest rate on excess reserves of financial institutions placed at the bank. Concerns about the weak global economy and that the BOJ would push rates even deeper into negative territory has driven the USD/JPY exchange rate below the psychological support of 110 yen per dollar on Tuesday, a level not seen since November 2014.

U.S. Dollar Index Technical Chart Click to enlarge

The DXY index is bumping into technical support at the 94 level, after the minutes of the March 15-16 Federal Open Market Committee, or FOMC, meeting revealed that many participants expressed concerns about appreciable downside risks of the global economic and financial situation, and that an April rate hike is unlikely. Despite some Fed officials continuing to paint a rosy picture of the U.S. economy, the U.S. dollar index is now at risk of a major move to the downside if this technical support can't hold.

U.S. Economic Outlook May Not Be That Rosy

There are warning signs that something is wrong with the U.S. service sector, accounting for nearly 80% of the private sector gross domestic product, or GDP. The reading of the Markit Economics monthly flash services purchasing manager's index, or PMI, came in at 51 for March, after plunging to 49.7 in February, missing the estimate of 51.4. A reading above 50 means the service sector of the U.S. economy is expanding.

In the press release, Markit chief economist Chris Williamson said, "Worst may be to come. The greatest concern is the near-stalling of new business growth. Demand for goods and services is growing at the slowest rate seen this side of the global financial crisis. It's not surprising therefore that companies lack pricing power, as reflected in a near-stagnation of average selling prices in recent months."

In the recent Markit report, "Faltering U.S. Economy Leads Global Slowdown", Williamson believes that if the Fed keeps further rate hikes on the table, slower economic growth may soon feed through to weaker hiring despite that surveys and official data showed job creation remaining robust.

The Fed may be caught between a rock and a hard place, because job growth is decelerating while inflation is on the rise. According to the Department of Labor, U.S. nonfarm payrolls has declined from 295,000 jobs added in October 2015 to 215,000 added in March 2016, while hourly wages inched up a mere 0.75% from $21.21 per hour to $21.37 per hour during the same period. Core personal consumption expenditures, or PCE, excluding food and energy, climbed from 109.86 in October 2015 to 111.555 in February 2016, a 1.54% jump.

According to the U.S. Commerce Department, consumer spending in February edged up just 0.1%, while January spending was revised downward from a 0.5% increase to a 0.1% gain. Weak consumer spending, along with other economic data, prompted the Federal Reserve Bank of Atlanta to revise the first-quarter 2016 GDP forecast to just 0.4% from the previous forecast of 0.7% on April 1.

EUR/USD Will Break Out If No April Fed Rate Hike

The euro, 56.7% weight in the U.S. dollar index, has been strengthening against the U.S. dollar, despite that the European Central Bank, or ECB, announced earlier in March that they raised monthly asset buys to 80 billion euros, from 60 billion euros, and cut its main refinancing rate to zero from 0.05%. The above-expectations QE came with a negative spin though, as ECB President Mario Draghi said after the monetary policy meeting that the central bank doesn't anticipate that it will be necessary to reduce rates further.

EUR/USD Technical Chart Click to enlarge

The euro bulls shrugged off the ECB minutes released on Thursday, revealing that several council members were willing to consider a deeper rate cut in March, and that future rate cuts also remain on the table. Although the Markit composite PMI indicated continuing weakness in the eurozone economy, retail sales rose for the fourth straight month in February, according to the European Union's statistics agency. EUR/USD is trading near the 1.14 euro per dollar level and is about to make a major breakout, since a Fed rate hike at the April FOMC meeting is more and more likely not going to happen.

Japanese Yen Continues To Strengthen

Concerns about weakening global economies and the BOJ's negative interest rate policy have put buying pressures on the Japanese yen as a safe-haven currency and hedge. The Japanese yen, 13.6% weight in the U.S. dollar index, continues to strengthen despite the possibility that Japan's economy could fall back into recession. The Cabinet Office of Japan said in February that Japan's GDP shrank an annualized 1.4% in the fourth-quarter 2015, considering that weakness persists in private consumption, which accounts for about 60 percent of the economy.

Weak economic data continues to pile up, as the recent Tankan survey released by the Bank of Japan showed a sharp decline in business confidence in the first quarter this year. According to Barron's, Prime Minister Shinzo Abe will introduce a big fiscal package, somewhere between 5 trillion ($44 billion) and 10 trillion yen ($88 billion), in the second-quarter this year. The fiscal stimulus package will likely come before the elections for Parliament in July.

USD/JPY Technical Chart Click to enlarge

The USD/JPY turned bearish after the currency pair broke down the ascending wedge chart pattern in early December. If global outlook worsens, the currency pair could dip below 108 yen per dollar, at which point the Japanese government may intervene. In early April however, Mr. Abe ruled out intervening in the currency markets to halt a surge in the yen.

Weak British Pound Sterling Is Unsustainable

The pound, 11.9% weight in the DXY, continues to be under selling pressure following last month's terrorist bombings in Brussels. Nigel Farage, leader of the pro-Brexit, anti-immigration United Kingdom Independence Party, blamed the blasts on the EU's freedom of movement rules and accused Britain's pro-EU politicians of "putting lives at risk for the sake of political union". He also suggested the attacks could strengthen the campaign for Britain to leave the EU in the U.K. referendum, to be held on June 23.

The Bank of England is expected to keep British interest rates at a record low of 0.5% until next year, as the U.K. economy is showing momentum but the trade deficit continues to widen.

GBP/USD Technicall Chart Click to enlarge

GBP/USD has been moving in a descending wedge chart pattern since early 2014. The currency pair bounced off the lower trendline support of the descending wedge at 1.3833 dollars per pound earlier this year, but the uptrend was not sustainable as the long-term sentiment for the British pound sterling is bearish. The GBP/USD could continue to grind slower higher during the first-half of 2016, while the referendum and U.K. politics remain a dark cloud. A weak pound could provide some support to the dollar, but this might not be sustainable if the U.S. economy also begins to falter.

Conclusions

The U.S. dollar index is now at risk of a major move to the downside if the technical support at the 94 level can't hold. There are some warning signs that the U.S. economy is not as rosy as some Fed officials have been painting it to be. The U.S. dollar index could be under selling pressure if there is no Fed rate hike at the April FOMC meeting. Despite the fact that the ECB has signaled that more stimulus is still on the table, the EUR/USD is trading near the 1.14 euro per dollar resistance level and is about to make a breakout to the upside.

The Japanese economy could trigger the BOJ to push rates even deeper into negative territory and put more selling pressure on dollar. A weak British pound sterling could provide some support to the dollar, but this might not be sustainable if the U.S. economy also begins to falter. The currency markets may not yet have priced in the ballooning U.S. debt, which is now approaching $20 trillion.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.