Thursday was a good day for the dollar index (UUP) as it experienced one of its strongest one-day rallies of the year. UUP neatly bounced off its 50-day moving average (DMA) and a level where the index experienced its last strong rally.
The dollar index bounces back
While the dollar's rally was indeed impressive, I think the Japanese yen is an even more interesting story. The yen sits at the cusp of renewed risk aversion. The traditional safe haven of paper currencies sits at one of those critical junctures that likely separates sustained weakness from an important reversal. More weakness from here will suggest that risk aversion may not be as strong as I might assume after witnessing the carnage in Thursday's stock market sell-off. Renewed strength, especially in combination with a resurgent dollar, will suggest that risk aversion is returning with a vengeance. Given the Federal Reserve reduced its economic forecasts for GDP and employment, a U.S. dollar rally from current levels must certainly confirm risk aversion.
The following charts show that the U.S. dollar is breaking out against the yen (FXY) with a run over the 50DMA, but other major currencies are fading neatly from resistance against the yen.
The U.S. dollar breaks out against the Japanese yen (USD/JPY)
The pound gains again on the yen (GBP/JPY) but fades away from 50DMA resistance
The euro fades away from the 50DMA against the Japanese yen (EUR/JPY) for the second day in a row
The Australian dollar fades from the 200DMA versus the Japanese yen for the second day in a row (AUD/JPY)
For now, I am maintaining my bullish stance on the Japanese yen, and I increased that position today. A failure of this position will have me switch to an emphasis on a bullish dollar position. I am currently expecting the dollar to ease back a little for a day or two after such a strong surge.
The iShares Barclays 20+ Year Treasury Bond (TLT) continued its bounce, but it is hard to gauge the signal for risk aversion given the Federal Reserve has extended its Operation Twist that shifts its portfolio ever further up the yield curve.
TLT continues to churn in a tight range but looks ready to resume its rally
Finally, the volatility index, the VIX, surged an amazing 16% to rally toward the critical 21 level. This is the level where last summer's sell-off began in earnest. A recovery above this level all but assures us to expect sustained, heightened levels of risk aversion.
VIX rallies back toward the critical 21 level
As a result of the one-day surge in volatility, iPath S&P 500 VIX Short-Term Futures ETN (VXX) looks like it is trying to print a rare triple bottom. This is also likely one of those few moments it makes sense to get long VXX for a short-term trade…even with the clear resistance directly overhead from the churn over the last month.
VXX attempts a third bounce from the bottom
Source for charts: FreeStockCharts.com
Be careful out there!
Additional disclosure: In forex, I am net long Japanese yen, net short U.S. dollar.