As fears of a long-awaited correction take hold of Wall Street, one trade is coming back in vogue: King Dollar.
The U.S. dollar index, which measures the greenback against a basket of other currencies, is at an 11-month peak. Meanwhile, the euro is at a nine-month against the buck.
So is the new safety trade in these turbulent times? According to the charts, the answer is yes.
“This is one of my favorite trades right now,” said Richard Ross, global technical strategist at Auerbach Grayson. “Of course, the stronger dollar really has bearish implications for equities. So you really want to watch this chart of the dollar index.”
He sees the dollar index as having traded in a well-defined trading range between 79 and 81.50 since September 2013. During that time, it made a double bottom, the second of which occurred this past May. Now that the index broke above the 81.50 level in July, Ross believes the next target will be 84, which is the height of the previous trading range added to the breakout.
“You want to be a buyer of that dollar [and] you want to be a seller of other riskier dollar denominated assets,” Ross said. “That’s going to provide headwinds in the emerging markets, which have been on fire since March…. Be long the dollar and be short or out of most everything else that has a risky connotation. “
Erin Gibbs, equity chief investment officer at S&P Capital IQ, also believes the dollar index is headed higher. A large part of that has to do with the fact that 58 percent of the index is made up of the dollar’s exchange rate with the euro.
“This is really driven by the euro/dollar exchange rate,” Gibbs said. “Since March of this year, the dollar has consistently strengthened against the euro and we can see that continuing.”
Monetary policy differences are what’s causing the dollar to pick up against Europe’s common currency, notes Gibbs. Both the European Central Bank and the U.S. Federal Reserve have a 2 percent inflation target for their respective economies. However, Europe is still struggling with higher unemployment and has almost no inflation. Gibbs sees Europe as being about two years behind the U.S. in terms of recovering from the financial crisis of the last decade.
Two other major components of the dollar index – the Japanese yen and the British pound – make up another quarter of the index. However, the yen has barely moved against the dollar this year, though the pound has appreciated and has been offsetting the dollar’s gains against the euro.
“But still, a much smaller percentage,” said Gibbs about the yen and the pound. “So it’s really all about that euro/dollar rate.”
To see the full discussion on the dollar index, with Ross on the technicals and Gibbs on the fundamentals, watch the above video.