U.S. Dollar Back at a Crossroads

Includes: UDN, UUP
by: Investment Pancake

Several signs suggest continued strength in the U.S. dollar may be a distinct possibility. Powershares U.S. Dollar Index Bear ETF (ticker symbol UDN) first tested support at its long-term 200 day exponential moving average in mid-December of last year. Since then, the security bounced higher, observing resistance roughly at it's 65 day and 30 day exponential moving average, and thus establishing it's first lower high. On Tuesday, it failed to observe support at its 200 day exponential moving average, locking in a new lower low. Lower lows and lower highs, and the conversion of technical support into technical resistance, portends further technical damage to this security is a distinct likelihood.

On the flip side, the Powershares US Dollar Index Bullish ETF (ticker symbol UUP) has established a new higher low at it's short and medium-term exponential moving averages, and is within striking distance of it's 200 day moving average and a new higher high. UUP is close, but not there yet.

Taken together, both securities signal that the U.S. dollar is now at a cross roads, or close to one. It would be premature to draw any conclusions at this point on the future direction of the U.S. dollar over the near term, but within a short period of time, it may become easier to do so drawing on technical trading data, at least. For instance, a sustained break below support at the 200 day exponential moving average for UDN, coupled with a sustained move above the 200 day exponential moving average for UUP, may very well be taken by some traders as the start of a new bullish trend in the price of the U.S. dollar. This scenario has not come to pass yet, and indeed, may not. Now, however, is the time to start considering whether we've simply been watching a blip in the price of U.S. dollars over the past month, or the start of something more important and lasting.

At the moment, the larger question for equities investors is what, if anything, a stronger U.S. dollar may imply? Growing risk aversion? If so, continued equities strength may be unlikely. Or perhaps, a stronger U.S. dollar implies growing investor demand for U.S. assets. If so, it may make some sense to reallocate equity investments out of non-U.S. dollar denominated vehicles. Would a stronger U.S. dollar imply lower commodities pricing? That is likely. And would that imply lower inflation risk? Perhaps, which could, in turn, enable the Federal Reserve to keep the floodgates open still longer, fueling growth in the price of domestic bonds and equities.

However you slice it, it has been premature thus far to worry too much about the implications of a stronger U.S. dollar, given that until recently, there was no reason to assume recent strength in the greenback was anything more than a blip within a larger bearish trend. But that trend is currently being challenged, and the outcome of this fight is well worth consideration at this point.

Disclosure: The author owns no positions in any securities mentioned in this article.