US Dollar Index sits at the crossroads

Investors are heavily short on the US dollar as CFTC’s CoT report showed record bearish levels on the Greenback at $4.1 billion

Summary:

• US dollar index fell to a 9-month low this week at 91.88 before recovering on the same day
• CFTC’s CoT report, as of April 26^th showed that traders were net short on the dollar, at $4.1 billion

The ICE Futures US Dollar Index managed to stage a comeback this week after falling to a 9-month on 3rd May at 91.88. The reversal came after investors sold the US dollar for straight 6-days, pushing the dollar index down 2.66% but the dollar managed to recover on that very day, closing on a bullish note and is currently into the third day of gains.

The weekly CFTC Commitment of traders report showed that investor sentiment in the US dollar continues to deteriorate, as of April 26th. Traders were net short on the US dollar, which widened by 2.3 billion on a week over week basis, to hit the most bearish levels at $4.1 billion, last seen in May 2014.

The sentiment in the US dollar started to deteriorate since February this year, when the dollar index was trading at 98 and started a steady decline as economic data from the US continued to disappoint, culminating in the Fed leaving rates unchanged in March and a GDP growth rate of 0.40%, which was the slowest pace of growth in two years.

This week’s bullish reversal came about as US Treasuries rallied earlier in the week and Fed members, Dennis Lockhart, and John Williams, who despite being non-voting members sounded hawkish. Most importantly, both the regional Fed presidents noted that the markets were being a bit too complacent on the rate hike probability and noted that the June meeting was still live. From a technical perspective, the reversal in the dollar could have very well been a short covering ahead of the ADP report that came out and more importantly today’s non-farm payrolls report.

US Dollar Technical Outlook

The weekly chart for the US dollar index makes for an interesting read.

• Median line break: After the rising median line was broken, prices quickly retested the breakout level near 98.50 – 98.0 and subsequently pushed lower. The declines incidentally stalled near the lowest support at 93.0 – 92.50. A weekly reversal is however needed to confirm this view.
• Trend line break: Prices broke out the trend line and stalled near the support, as illustrated with the rising median line
• Potential Head and Shoulders pattern: There is a strong possibility that the US dollar index could be in the process of forming a larger head and shoulders pattern with the neckline coming in near 93.0, although not a textbook pattern. The right shoulder needs to be formed near 98 – 98.50 which could then see the pattern unfold. In the worst case, watch for a reversal near 96.50

On the daily chart, taking a closer look we can see that price action is currently looking to potentially break out from the falling median line. But with resistance sitting close by at 94.0 – 94.50, we could probably expect the US dollar index to post a minor leg to the downside, to retest the 93.0 – 92.50 support. However, this retest is likely to be a soft test above 92.50. The eventual rally, if the resistance at 94.50 – 94.0 breaks is seen to be capped near 96.30 – 96.50. Between this level and 98.0, US dollar index could remain range bound into the next few weeks

To conclude, the US dollar index is likely to test the 93.0 support in the near term if resistance at 94 fails to give way to a rally. A dip to 93.0 could see renewed bullish momentum in the US dollar which could potentially push higher towards 96.30 – 96.50. Alternately, in the event that the US dollar index breaks below 92.50, we could expect to see strong declines taking the dollar index towards the 80 levels.