US Dollar Rally Enters Fifth Week - What Could Derail It?

David Rodriguez
US_Dollar_Rally_Enters_Fifth_Week_-_What_Could_Derail_It_body_Picture_1.png, US Dollar Rally Enters Fifth Week - What Could Derail It?
US_Dollar_Rally_Enters_Fifth_Week_-_What_Could_Derail_It_body_Picture_1.png, US Dollar Rally Enters Fifth Week - What Could Derail It?

US Dollar Rally Enters Fifth Week - What Could Derail It?

Fundamental Forecast for US Dollar: Bullish

The Dow Jones FXCM Dollar Index (ticker: USDOLLAR) strengthened for the fifth-consecutive week as the Japanese Yen continued to tumble, and the coming week brings a flurry of central bank activity as well as a highly-anticipated G20 meeting sure to cause further price moves. The month of January brought a significant turn in FX market volatility, and a sustained jump in volatility expectations may favor a continuation of the recent US Dollar uptrend through the foreseeable future.

Early indications from the G20 meeting suggest leaders will not make any groundbreaking changes to rhetoric on so-called “Currency Wars” and no reference to the Japanese Yen. Yet politics seem likely to dominate currency moves as Euro Zone tensions heat up and Japan’s government remains a major focus.

The USDJPY has defied gravity and continued to fresh peaks despite nascent signs of turnaround. It is nonetheless surprising to note that recent CFTC Commitment of Traders data shows large speculators have actually decreased their JPY-short positions (USDJPY longs) yet again. Large futures traders were their most net-long USDJPY in the week ending Dec 18 but since have reduced their exposure. A subsequent 800+ point rally suggests many non-speculative investment flows are driving further Yen weakness.

Subsequent outlook for the USDOLLAR mostly depends on appetite for further JPY depreciation, but it is important to note that the Euro, British Pound, and Australian Dollar have traded consistently lower against the US currency. What was an unabashedly bullish EURUSD trend in January has given way to a significant pullback.

The EUR reversal has ostensibly been driven by renewed Euro Zone tensions amidst political scandal in Spain and upcoming elections in Italy. CFTC data shows that speculators have likewise aggressively scaled back bets on continued EURUSD gains in the week ending February 12. On a technical level, it will be critical to watch whether the Euro is able to hold above key support near $1.32

We thus head into the coming week with a close eye on political developments across the world—virtually certain to produce uncertainty and sharp short-term price swings. More predictable economic event risk will be concentrated on Wednesday and Thursday with US CPI and PPI inflation figures due as well as minutes from the most recent US Federal Open Market Committee (FOMC) meeting.

The pronounced USDJPY uptrend helps explain why the Dollar Index continues to hit fresh peaks alongside the similarly high-flying S&P 500, but longer-term correlations suggest this is unlikely to last forever. Cyclical studies warn that US equities may see a key test as the S&P hits a key milestone from its all-time peaks. All else remaining equal, we suspect that a turn lower for stock markets would almost certainly favor the safe-haven US Dollar.

Market volatility remains high, and we like the odds for further topside continuation in the USDOLLAR through the week ahead. The key question remains whether politics will get in the way of market trends, and it will be particularly significant to watch whether the S&P 500 can continue to fresh peaks .- DR

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