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The weakness in the U.S. Dollar Index is a symptom of the Federal Reserve's unwillingness to choke off easy access to capital; that weakness is likely to continue as the Fed nears the end of its rate-hike campaign despite the specter of record commodity prices. Extremes in the monthly oscillator in the lower panel of the monthly Dollar Index chart below have generally correlated with tops in the index (as indicated by the vertical pink bars), with the exception of the false signal in 1998. The oscillator is currently above its upper trading band, so I expect the Dollar Index will fall below its last pivot high. The horizontal red lines on the graph represent monthly closes below a prior pivot high point. The chart shows that in three out of four instances of a monthly close below a prior pivot high, the Dollar Index has subsequently dropped further (the one exception is marked by a yellow oval).
The most recent monthly pivot is at $88.78. Although the index is below this level, there hasn't yet been a monthly close below it. Nonetheless, with the long-term oscillator at a point where trends have rolled over in the past, the Dollar Index is clearly at risk of putting in an important top.
Closer examination through a weekly chart suggests that the weakness is for real and that it's only a matter of time before the trend turns down on the monthly chart. The first bearish claw mark on the chart is that the 40-week moving average has just started to roll over. Take a look at the normalized Bollinger Band in the lower panel. (Normalizing the indicator means that the bottom band is set to zero and the top band equals one; the indicator (in red) is the value of the closing price in relationship -- percent wise -- to the upper and lower bands.) The indicator is breaking below successively lower trend lines in a fanlike fashion. This is suggestive of a market top. The last bearish point is the head-and-shoulders topping formation (marked with the letters "s" and "h" on the chart). A weekly close below the pivot low of $88.33 would imply a downturn in the Dollar Index.
Strength in the euro also points to weakness in the dollar. The euro closed above a prior monthly pivot low last month on the monthly euro-dollar chart above. The only prior close above a pivot low kicked off the euro's run in 2001 (marked with a yellow oval on the chart). The long-term oscillator in the bottom panel is also starting to turn up from an extreme oversold level. The euro appears to be primed to move higher.
The euro is trading above its 40-week moving average on the weekly chart above, and this key average is starting to turn up. The head-and-shoulders bottom also favors the euro. The pattern was initiated with a significant downthrust (point LS) outside the lower band of the five-bar moving average of price (thick blue bar). This is suggestive of strong downside momentum. In the formation of the head (letter "h"), the euro went lower, but there wasn't a significant downthrust. This lack of momentum despite lower prices is a positive divergence. Recently, the euro has recovered and a close above the pivot at $1.2151 would mean that the bottom is in. The price-structure analysis indicator in the bottom panel tells us how the current price relates to past pivot points and trend lines formed by those pivot points. The indicator often leads price, and it is now breaking out, suggesting that the euro is likely to rise against the dollar in the future. The implications of a weaker dollar are obvious: Hard assets should be favored over paper assets and foreign shares will likely outperform U.S. shares. Equities will continue to perform well as long as liquidity remains high. The weekly chart below of gold (green line) and the S&P 500 supports this view. They have traveled in the same direction for almost five years now during this period of high liquidity and a weakening dollar.
Guy Lerner is an anesthesiologist and freelance writer who trades for his own account. He blends technical and fundamental analysis to find factors that lead to sustainable moves in the markets. Lerner's approach is research-driven and focuses on supply-demand issues, investor sentiment, intermarket relationships and monetary liquidity. He is a member of the Market Technicians Association and is the founder of TheTechnicalTake.com, a Web site that offers content, commentary and strategies for investors and traders. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. He appreciates your feedback and invites you to send your comments by clicking here.
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