The Outlook For The US Dollar Index

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Alistair Meadows
Alistair Meadows

Originally created in 1973, the Index is a weighted geometric mean of the value of the US Dollar against a basket of global currencies, such as the Euro, the Yen, Sterling, the Canadian dollar, the Swedish Krona and the Swiss Franc. By far the largest weighting is against the Euro (57.6%), such that for all practical purposes, a bullish view on the US unit implies a negative one on the Euro (and vice versa).

Jobs Data

Extremely poor jobs data last week has accelerated the bearish trend (ironically, just after Goldman Sachs closed their short-dollar recommendation). It fell nearly 2% from there, as of 11/5/21, testing the 90 area.

A sharp rebound has occurred as equity markets rebounded, but a re-test of those lows still appears likely, firstly to the recent lows at 89.94 and possibly to the January lows of 89.16.

As stock markets around the world have risen in the last few days, the Index has retreated [1], which sets up the potential reversal neatly.

US Dollar Index Daily May 21

Appetite For Risk

With equity markets still trading at lofty valuations and wage inflation looking as if it has made a comeback, as big US firms struggle to attract workers, global risk appetite is still vulnerable to a fall; inflation expectations too are now rising sharply, which may force the Fed to respond at some point with interest rate increases.

What that does for both equities AND the US Dollar is not assured, but a bullish outcome is more likely for the latter than the former.

Bear in mind, however, that as the Index is a composite of major currencies versus the Dollar it will rise and fall more slowly than do individual cross rates (e.g. Euro/Dollar), typically taking 2-3 extra days to signal a trend change.

One can either buy the Dollar against the Euro or buy the Dollar Index itself, which can be traded via most spread-betting firms, or futures brokers.

Look for a re-test of the previously cited low points as the decline does not yet look complete, especially in terms of sentiment (there are not yet enough US Dollar bears around!)

An intra-day break of the lows, (i.e. below 89.94), followed by a swift close above those levels is often a reliable guide to a reversal. Stop losses need to be placed below the 89 level, with an upside target of at least 93.50 and possibly as high as 94.60 leaving a 2:1 or even 3:1 risk reward ratio.

[1] The US Dollar tends to act as a “safe haven”, rising when (stock) markets fall and vice versa when they gain.