Thanks largely to the surging euro, the U.S. dollar index (NYSEARCA:UUP) took one of its nastiest one-day tumbles since last October, falling 1.3%.
click to enlarge images
The U.S. dollar tumbles, validating resistance at the QE2 reference price while the short-term uptrend remains intact
I believe this drop all but confirms staunch resistance to further gains for the dollar index above what I have called the QE2 reference price, the price level of the dollar index right before Ben Bernanke telegraphed QE2 at the end of August, 2010. If the dollar continues to fall from here, such a move will likely take some pressure off the Federal Reserve to come up with more quantitative easing magic. However, it is not so easy to say that the dollar will continue to plunge from these levels either. In particular, the euro (NYSEARCA:FXE) and the British pound (NYSEARCA:FXB) are bumping against resistance at their respective 50-day moving averages (DMAs) with the U.S. dollar. While the Australian dollar (NYSEARCA:FXA) is not in the dollar index, it is informative to review the important price levels for the Aussie dollar given its renewed strong correlation with the S&P 500 (NYSEARCA:SPY). I post the relevant charts below using the actual forex currency pairs and include other major currencies.
While Friday's rally was strong (1.1% using U.S. Eastern time), the euro pulled neatly back to close just below the 50DMA. This line served as strong resistance to the euro's recovery earlier in June. I think a close above the 50DMA will be extremely bullish for the euro and confirm the market's positive change in sentiment on macro-economic developments in the eurozone. Under such a scenario, I will look for a relatively swift retest of the (still declining) 200DMA.
The euro makes another attempt to break above the 50DMA against the U.S. dollar
The strategy I outlined in mid-June has worked extremely well for buying dips in the British pound and selling on rallies toward the 50DMA with the U.S. dollar. I was primarily motivated by the potentially bullish economic implications of the British government working in concert with the Bank of England (BOE) to stir up more lending in the economy and free up credit. (Of course, you could have also done well to reverse this strategy by FADING the pound whenever it approached the 50DMA resistance). It was difficult buying into Thursday's deep dip but it paid off tremendously the following day as seen in the chart below for GBP/USD. The 50DMA continues to decline sharply, so I am only interested in buying deeper dips going forward. For now, I am assuming the 50 and 200DMA will continue to cap rallies in the British pound until some freshly positive catalyst arrives.
The British pound attempts to break resistance again at the 50 and 200DMAs
The U.S. dollar's bounce continues against the Japanese yen (NYSEARCA:FXY) with the 200DMA still providing a general uptrend for June's bounce. This setup is now also supported by the 50DMA. A weakening yen is generally bullish for "risk on" trades and the stock market as a whole. The earlier warning flashed by the yen pointing toward risk aversion appears all but over now (especially with the volatility index, the VIX, failing spectacularly last week).
The U.S. dollar clings to its recent rally against the Japanese yen
The Canadian dollar (NYSEARCA:FXC) is not too informative. It has simply bounced around parity since last September/October. As a commodity bull, I am more inclined to bet on the Canadian dollar than against it. However, recent news that Canada's housing bubble is finally close to bursting has me worried, and I do not plan to hold positions in the Canadian dollar for longer trades.
The Canadian dollar is likely headed back toward parity against the U.S. dollar
Overall, on balance, it looks like a near wash of bullish and bearish forces playing against the U.S. dollar. Until a fresh catalyst comes along, perhaps from the coming July non-farm payrolls report, I strongly suspect the U.S. dollar will bounce around in a tight range. Even news that sends the dollar selling off more may just set the floor of this range. You can rightfully argue for a drop or a rally on bad or good employment news!
Perhaps the Australian dollar is the wildcard. The Reserve Bank of Australia (RBA) is making its next interest rate decision on July 2nd. While I agree with the "consensus" that the RBA will keep rates at 3.5%, I also expect the RBA to reaffirm its desire for a weaker currency. For example, the RBA could express its surprise that the Australian dollar remains above parity with the U.S. dollar. The chart below shows how quickly and sharply the Aussie has rebounded since plunging to eight month lows on June 1st. For the last two weeks, AUD/USD has bounced between parity and presumed resistance at the 2010 and 2011 closing level. A break above this range, especially above the 200DMA, will be very bullish for the pair. For now, I remain net bearish on the Australian dollar although my hedge going long AUD/USD has put me in a more neutral net position.
Australian dollar is looking for a catalyst to breakout of the recent two-week range. The RBA might just deliver.
Finally, the plunge in the dollar just happened to coincide with other important levels in oil (NYSEARCA:USO) or (NYSEARCA:DBO), gold (NYSEARCA:GLD), and silver (NYSEARCA:SLV). All three of these commodities jumped sharply largely in response to the drop in the dollar, and, presumably a little more optimism about the global economy. I strongly suspect that absent any new bearish catalysts, oil (USO up 7.9%), gold (GLD up 2.7%), and silver (SLV up 4.0%) have successfully retested critical support levels. The charts below demonstrate the remarkable synchronicity in last week's moves. (I extend out the charts for GLD and SLV to show the downtrend from the last peaks that still need to get broken for these precious metals to return to bullish form).
USO bounces sharply off October lows
May's retest of support remains firm for GLD
SLV had a close call with critical from Jan and Dec, 2011 getting temporarily broken before Friday's sharp rally
Source for charts: FreeStockCharts.com
Note that I still think the gold and silver miners are the best way to play the precious metals going forward.
Be careful out there!