On Monday, September 21, the US dollar index experienced the most significant rally in weeks. The index not only bounced higher, but it also put in a bullish reversal on the daily chart. The dollar index traded to a marginally lower level than on September 18 and closed well above the previous session’s high at the end of last week. On Tuesday, September 22, the index followed through on the upside with another gain that took it to over the 94 level for the first time since July 27.
The dollar is the world’s reserve currency. During periods of rising fear and uncertainty, the dollar often serves as a safe haven. On Monday, September 21, selling hit the stock market with all of the leading indices posting losses. The DJIA fell by over 500 points, crude oil declined below the $40 per barrel level, and even precious metals prices became victims of risk-off behavior in markets. The dollar and US bond market attracted buying as capital looked for safe spots to hide from ubiquitous selling. The sad death of Supreme Court Justice Ruth Bader Ginsburg after markets closed on Friday vaulted the US election to a new level of discord. President Trump will nominate a replacement for the Justice, while his opponent and Democrats insist that he waits until after the election. Meanwhile, any hopes of cooperation over further stimulus programs may have gone out of the window because of the newest political issue caused by the revered Supreme Court judge’s passing.
The dollar has been trending lower since March. Even after the latest bounce in the greenback, the trend remains lower. The Invesco DB US Dollar Index Bearish Fund (UDN) moves higher as the dollar index falls.
Currencies can trend for long periods
The dollar is the reserve currency of the world, which means that central banks worldwide favor the dollar when it comes to reserve holdings. The dollar is the most common currency when it comes to global commerce. Reserve status comes from political and economic stability in a freely convertible currency compared to other foreign exchange instruments.
While the dollar, euro, and other reserve currencies move higher or lower on market forces, governments tend to manage values to avoid significant changes. Individual or coordinated intervention in the currency markets can be commonplace to preserve stability and prevent damaging shifts in value that would ripple through the global financial system. When changes in value occur, they tend to occur over long periods. Therefore, currencies tend to trend slowly.
As the quarterly chart shows, since 1985, the index has had four significant trends. From 1985 through 1992, the dollar index declined. A bullish trend began in 1992 and lasted until 2001. From 2001 through 2008, a bearish trend sent the index lower. The latest bullish price action lasted from 2008 through 2016. In 2016, the dollar index peaked at 103.815. While the flight-to-quality price action in March 2020 took the index to a marginally higher high at 103.96, the index quickly rejected that level. It fell below 92 before recovering to around 94 on September 22.
Quarterly historical volatility has ranged from 4.65% to 15.29% over the past three and one-half decades. The most recent reading at 5.57% is closer to the low than the high from the early 1990s. The index has demonstrated that trends can last for extended periods. Time will tell if the greenback consolidating or will continue lower. On the long-term chart, the area of critical technical support stands at the February 2018 low of 88.15. A move below that level would signal a bear market in the world’s reserve currency.
The latest Fed meeting was bearish for the greenback
Inflation is an economic condition that eats away at the purchasing power of a currency. In August, at the Jackson Hole virtual conference, the Federal Reserve Chairman told markets that the central bank’s 2% target rate was no longer a line in the sand that would trigger short-term hikes in the Fed Funds rate. Chairman Powell explained that an average of 2% was the target, which meant that the central bank would tolerate inflation above that level for a period to achieve an average. At the September FOMC meeting, the central bank formalized the policy, which was a departure from the past.
Allowing inflation to climb is a bearish factor for the value of the dollar. Allowing its purchasing power to decline is likely to weigh on the currency’s value over the coming months and years. Moreover, unprecedented levels of central bank liquidity and government stimulus and rising deficits amount to increasing the supply of dollars, which dilutes the US currency’s value.
The election and political divisiveness continue to weigh on the world’s reserve currency
On November 3, voters in the US will select the who will sit in the White House over the coming four years. As President Trump stands for re-election, he faces former vice president Joe Biden. The election comes as the global pandemic continues to weigh on the US and global economies. At the same time, bouts of civil unrest over the past months have exposed social divides within the nation. While the Presidential contest takes the limelight, the balance of power in Congress is also up for grabs. The election will determine the majority in the House of Representatives and the Senate. A sweep by the Democrats would shift many policy initiatives from the past four years. A mixed result would likely cause gridlock in Washington to continue. A victory by the sitting President with a Republican majority in the Senate would preserve the status quo.
Until the voters determine the path of political power, uncertainty over the future of policy is likely to cause volatility in markets across all asset classes, and foreign exchange is no exception. The US and the rest of the world are waiting and watching. A close contest with no clear winner or a challenge to the election results could prolong the uncertainty. Currency markets favor a clear path. Therefore, a cloudy result from the election process could continue to weigh on the value of the US currency.
The recent passing of Justice Ginsberg and Republican support for an appointment to replace her are only exacerbating political divisions in Washington and throughout the nation.
Levels to watch in the dollar index
From a short-term perspective, we could see lots of price variance in the dollar index over the coming weeks as the election approaches. In the aftermath of the contest, a trend is likely to develop. Aside from politics and policy, the unprecedented level of liquidity and stimulus and increasing money supply are not bullish factors for the dollar over the coming months and years.
The daily chart shows that the dollar index put in a bullish reversal on September 21. It fell marginally below the September 18 low and closed the session above the previous session’s high. The index followed Monday’s bullish pattern by continuing higher on September 22.
The weekly chart shows that a close above 93.63 on Friday, September 25, would put in the same bullish reversal on the weekly chart. The dollar index fell to a low of 91.725 during the week of August 31. The move below the September 2018 low of 93.395 in late July broke a significant level of technical support in the dollar index. However, the downside target remains at the February 2018 low of 88.15, a technical line in the sand of support on the downside.
On the upside, the first level of resistance stands at the high of 97.81 from the week of June 29. I expect we will see increased price variance in the US currency between the 88.15 and 97.81 levels between now and November 3. In the aftermath of the election, we could see a significant trend develop.
The economic landscape in the US points to a falling dollar, but the rest of the world continues to face the same challenges from the pandemic. Politics in the US are turbocharging the environment of uncertainty.
Buying UDN on any rally in the dollar index
The most direct route for a risk position in the dollar index is via the over-the-counter foreign exchange market or the futures arena. The Intercontinental Exchange offers futures contracts on the dollar index. For those looking to position in the dollar index without venturing into the OTC or futures markets, the Invesco DB US Dollar Index Bearish Fund (UDN) and its bullish counterpart (UUP) provide an alternative. The fund summary for UDN states:
Source: Yahoo Finance
UDN has net assets of $52.62 million, trades an average of 152,540 shares each day, and charges a 0.75% expense ratio. The dollar index fell from 103.96 in March to 91.725 on September 1 or 11.77%.
Over the same period, UDN rose from $18.96 to $21.37 per share or 12.71% as the ETF product slightly outperformed the dollar index continuous futures contract on the downside.While I believe the index is heading lower, the UUP product is available for those looking for the index to recover. UUP has net assets of $ 463.34 million, trades an average of 960,182 shares each day, and charges the same 0.75% expense ratio.
Expect lots of volatility in the dollar index over the coming weeks. UUP and UDN are useful trading tools for nimble traders with their fingers on the pulse of the foreign exchange market and the world’s reserve currency.
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