We Could See A Breakout For The Dollar

| About: CurrencyShares British (FXB)

Summary

The dollar has peeked higher from an important level.

Safe haven status may be one driver.

The other driver is higher US yields.

The dollar (NYSEARCA:UUP) looks like it wants to go higher. The ETF UUP has a key level that looks like it is going topside. The reason for the move is probably driven by two factors: a flight to safety after the British pound meltdown and higher US interest rates.

Let's look at the dollar chart.

Click to enlargeSource: Interactive Brokers

We drew a line where we think had the most important trading action over the last two years. The price is just under $25 UUP. We put arrows to show you where this line was a key level to hold, breakout, or breakdown. Traders have used this line to determine trading decisions.

Now, as you see on the chart above it looks like UUP is starting to make a move above this line. It's done that before of course, but we wanted to take note.

Why Is The Dollar Strengthening?

There are two main reasons we think the dollar is going up:

1. The British Pound

2. US Relative Interest Rates

The British Pound

The British pound (NYSEARCA:FXB) disaster last week makes the dollar a safe haven. Many traders may have been trapped in the pound when it was hit fast and strong. After that traders probably pulled-in and got back in a "safe" currency. That helps the dollar.

Also when there is currency volatility in the world there is a need for safety. Currency volatility can typically be a prelude to market (NYSEARCA:SPY) volatility. So far we only really have the pound fluctuating in a big way but it could cause fear in other currencies. That would cause fear in markets and lead investors to buy safe-haven type assets like the dollar. We are not there yet but that may be some of the early strength in the dollar.

US Relative Interest Rates

Yields in the US and around the world have been moving up of late.

Here's the chart of US 10 year yield.

Click to enlarge

Source: Trading Economics

The 10 year yield in the US has been rising and is higher than most other developed countries' 10 year yields. This may be what's getting investors to buy dollars. They want that 1.7% yield on the 10 year and the higher yield on US notes and bonds (NYSEARCA:TLT).

We think it makes sense that yields are going up because we've said that we think the Fed is on hold through 2016.

If the Fed is on hold inflation risks increase which can drop bond prices. That was the move.

What's strange though is that the market appears to be increasingly expecting a US Federal Funds rate increase in December. A rate hike though would probably cause recession fears which would mean longer term yields would go down with recession fears.

The movement of the longer term yields tells us that bond investors don't believe a rate hike is in the offing.

That said the Fed Funds Futures are predicting a 60% chance for a rate hike in December.

If the street unwinds from that high expectation of a rate hike, bond yields could potentially get more of a lift which could attract more demand for dollars. We'll have to see how it plays out. We are not necessarily bearish on bonds here.

Stop Loss

Where would we say we're wrong? We'd guess that if UUP closes below $24.50 the market is telling us we're wrong on this move and it would be a reason to exit.

Dollar's Impact On Gold And Oil

The move up on the dollar could be a wind in the face for gold (NYSEARCA:GLD) and oil (NYSEARCA:USO). Obviously there are other factors driving these commodities but the dollar in isolation may turn to a headwind.

A close below our UUP stop loss of $24.50 would also be meaningful as a sign removing that headwind to gold, oil and other dollar-affected securities.

Conclusion

The dollar looks like it may be moving higher. It's probably being driven by safe-haven status after the pound's hit. US bond yields may also attract more investment dollars from reach-for-yield foreign investors. The dollar up move could also be one factor against oil and gold.

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