What the Dollar Bounce Does Not Mean

As regular readers know, I have been looking for the U.S. dollar to begin performing better. I have argued that the greenback had already bottomed against half of the four G7 currencies -- the Canadian dollar and the British pound -- and that its main weakness was cyclical in nature, not structural as the pessimists maintain.

With the recovery in recent days, the U.S. dollar is trading at its best levels since late March against the euro and its best level since late February against the Japanese yen and Swiss franc. Its recovery has been predicated on ideas that the Federal Reserve paused after easing monetary policy since last summer, that the financial crisis is easing, and that there is a greater appreciation of the economic challenges being faced by other major industrialized countries.

One might expect strategists with my views to be jumping up and down about the dollar's better tone. And indeed the technical and fundamental backdrop for the dollar has improved markedly. Yet prudent traders and investors need to keep things in perspective and take it one step at a time.

The Euro Tests a Key Level

The euro has barely achieved the minimal technical retracement of sharp advance that I would date beginning Feb. 7 near $1.4440. After breaking above $1.60 in mid-April, it has now slumped a little more than 5.5 cents, and just shy of the 38.2% retracement of advance which comes in near $1.5420. A convincing break of this level is needed to sustain the downside momentum, from a technical point of view.

At the same time, it is important to note that the technical tone of the euro has deteriorated. I have often used the five-day and 20-day moving averages as guides for the underlying trend. For the first time since late February, the five-day moving average of the euro has fallen below the 20-day moving average, and also for the first time since then, the euro has finished the North American session below its 20-day moving average (since April 24).

Ideally, corrective upticks in the euro should hold below the 20-day moving average, which comes in today near $1.5750 and all the better if the $1.5650 cap proves sufficient.