Michael Kramer | Sep 25, 2020 09:56
This article was written exclusively for Investing.com
The dollar is surging higher and is wreaking havoc on risk-assets. The dollar index broke above a critical level of technical resistance on September 22. Now it may be off to the races.
Simultaneously, the euro is breaking down, with it accounting for a significant portion of the dollar index. A euro sell-off and push into the dollar is likely to result in a breakdown of equities and commodities.
The spread on the US 10-year Treasury rate and German 10-year Bund rate may be about to throw gas on the fire. The difference between the yield on the 10-year Treasury and 10-year Bund is on the verge of breaking out. Should that happen, it would likely help to strengthen the dollar’s advance, making it even more painful for risk assets.
The dollar index, which values the dollar against a basket of currencies, rose above a level of technical resistance around 93.50 on September 22. Since that time, the index has moved higher to around 94.30. The index appears to be in the process of completing a bullish reversal pattern known as a reverse head-and-shoulders. Based on that, it seems the index could rise to its next significant level of resistance around 96 and potentially as high as 97.70.
The euro is showing similar signs of reversing, but in this case, that means heading lower. The euro recently attempted to break out of a long-term downtrend against the dollar, which started in July 2008. That downtrend has been firm, with the euro failing three prior times to advance during the past decade. However, in July, for the first time, the euro was able to rise above the downtrend around 1.17 to the dollar. But now the euro is failing at 1.17 support and potentially heading back below the downtrend. Should the euro fall below the downtrend, it could result in the currency dropping to around 1.14.
The signs for a further euro drop are building with a relative strength index that has been trending lower since July, despite the euro breaking out. It created a bearish divergence, with a rising price and falling relative strength index; it signifies the euro is heading lower over time.
The dollars move higher could even pick up some steam, especially if we begin to see rates in the US rise or German yields fall. The spread between the interest rates fell sharply in March as yields on US Treasuries fell at a much faster pace than German bunds. It appears the steep decline in the spread is unwinding and could be about to widen again, potentially back to 1.5% from 1.2%.
A strong dollar is likely to be bad news for inflation-linked and inverse correlation trades such as gold and silver. Both metals have already started to feel the pain of the stronger dollar, with gold dropping by as much as 10% from its early August highs. The technical chart suggests gold could fall even further, potentially back to around $1,790.
Chart courtesy of TradingView
It could also be trouble for equities, as multinationals would likely feel the pinch from the stronger dollar. It would hurt US multinationals, acting as a headwind, reducing revenue and earnings results. Additionally, the dollar’s decline gave the equity market a considerable boost as it started to fall.
A chart with an inversion of the dollar index overlayed with the S&P 500 shows just how closely the two have followed each other since the March lows.
Chart courtesy of TradingView
A few weeks ago, there wasn’t much talk about a dollar turn around. Now, that appears to be happening as coronavirus cases begin to surface in the eurozone, sending investors into the dollar. It remains to be seen if the dollar’s recent advance may only result in a medium-term move in what could be a longer-term downtrend. But it doesn’t mean it can’t create problems for investors in the meantime.
Written By: Michael Kramer
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