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CURRENCY ANALYSIS

Looking at the Dollar’s Downside Correction

Looking, Dollar, Downside, Correction, Currency Analysis, fx trader, forex

20 Jan 2017

The US dollar spent the first month of the new year correcting lower after a strong advance in the last several months of 2016. We argue that the correction actually began in mid-December following the Federal Reserve's rate hike. Over the last two week, we have been cautioning that greenback's downside momentum was fading and the correction was coming to an end. We retain that view and have been encouraged by the recent price action.

The Dollar Index found a base 99.80-99.90. It spent the last session completely above 100 for the first time in a week. After being essentially flat the first week of the year, the Dollar Index lost 1% in the second week and 0.5% in the third week. Last week it fell about 0.25%. The fading downside momentum is not the same thing as a renewed uptrend. For that, it must move back above the 101.00-101.30 area.

A small bullish divergence is being seen in the RSI, where the new lows in the index were not matched with new lows in the technical indicator. The MACDs and Slow Stochastics have not turned, but they have flattened out, which are still consistent with the next significant move being to the upside. That said, a break of the 99.40-99.60 area would undermine the constructive technical case we have been building.

The euro's five-week advance was snapped, as the single currency finished marginally lower on the week. The euro stalled near $1.0770, in front of the 50% retracement target (~$1.0820) of the sell-off since the US election. The MACDs and Slow Stochastics have not turned down yet, but they seem poised to do so next week. The euro has not violated the trend line drawn off the January 3 low near $1.0340. It is found on Monday near $1.0675 and $1.0740 at the end of next week. We had suggested a close below $1.0660 would bolster the chances that a high is in place, but more cautious participants may want to monitor the 20-day moving average. The euro has not closed below it since January 3. It was near $1.0620 before the weekend.

The dollar rose against the yen last week for the second consecutive week and the third advance in the past four weeks. The dominant chart pattern is a potential double bottom near JPY112.50. The neckline was formed by the high on January 19 near JPY115.60, which also corresponds with a 50% retracement objective of the dollar's push lower from the early January high near JPY118.60. The minimum measuring objective of the double bottom projects toward that high. The dollar finished the week above the 20-day moving average (~JPY115.10) for the first time since January 4. The Slow Stochastics have turned higher, and the MACDs are poised to do so. The RSI is also trending higher. A break of JPY114.25 would be an initial indication that this constructive outlook may be wrong.

From the January 16 gap lower opening through January 26, sterling gained almost 6% against the US dollar. It reached almost $1.2675 before running out of steam. We identified several technical considerations that suggested potential toward $1.28. First, a potential inverse head and shoulders pattern may have been carved. The neckline was near $1.2430.  The second pattern is a potential flag pattern. The pole was created on January 17 rally (sell the rumor, but the fact) spurred by May's speech. Flags fly at half-staff, and this one was formed in the following three sessions.  The $1.28 area that both patterns project toward corresponds to a 61.8% retracement of sterling's decline from the early September high near $1.3450. It is too early to give up on the $1.28 target, but if it is not seen soon, the risk is of a setback. The Slow Stochastics and MACDs are still rising but could turn down on additional weakness.  Initial support is seen a little ahead of $1.2500, and a break of $1.2450 would also boost the risk that a high is in place.

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