Dollar ends period of retrenchment

Updated: 2010-11-29 11:17

By Daryl Guppy (China Daily)

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Dollar ends period of retrenchment

The rise in the US dollar Index is more than just a short-lived rally. The rise is now strong enough to suggest a change in the direction of the trend. The dollar is moving from a position of weakness where it touched $0.755 against a basket of currencies to a position of increasing strength. A strengthening dollar is the opposite to the result many people expected when the US Federal Reserve announced a second round of quantitative easing. A stronger dollar calms the flames of a currency war created by a weaker US dollar. However, a stronger dollar keeps the pressure on currencies the US claims are under-valued because this disparity will increase as the dollar strengthens.

Quantitative easing is a polite term for printing more money. This has an inflationary effect and money has flowed into US markets with the Dow Jones Index touching 11440. It has a potential inflationary effect outside the US and the flow of hot money into Asia is a growing concern for business and policy markers.

The policy can also debase the currency so the usual flow-on effect is a rise in gold and silver as investors move into hard assets. The first warning sign that this effect was not developing was when the gold price began to fall. This warning signal was confirmed when the gold price fell below $1,360, breaking the up trend that had been in place since July 2010. The gold price rise this last week is a knee-jerk response to the growing tension in the Korean peninsula rather than to movements in US economic policy. The old up trend line is now acting as a resistance level.

Is it a temporary rally or a genuine trend change for the US dollar? Analysis of the US Dollar Index chart suggests a genuine change in the trend.

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The US Dollar Index chart is dominated by support and resistance levels and two trend lines. The two down trend lines start from a single high near $0.89. The lower trend line acted first as a resistance level, and then more recently as a support level. The higher trend line has mainly acted as a resistance level. The rally breakout to $0.795 has moved above the upper trend lines and then used the trend line as a support level.

This combination of multiple trend lines and the reversal of their support and resistance function is part of a fan pattern. The fan pattern is a long-term trend reversal pattern. This supports the long-term rise in the US dollar. The target levels for a rise are determined by the horizontal support and resistance levels.

The most important of these levels are located near $0.795 and $0.815. The breakout above the downtrend line first stopped at the resistance level near $0.795. The retreat tested the trend line as a support level and then quickly rebounded above resistance at $0.795. The break above $0.795 is very bullish and sets an upside target near $0.815.

Rallies are created by traders, but when they attract support from investors then the rally has the potential to develop into a trend change. The Guppy Multiple Moving Averages (GMMA) indicator tracks the behavior of traders and investors. The current rally shows the short-term GMMA have moved above the upper edge of the long-term GMMA. The long-term group of averages showing investor activity has also compressed and moved upward. This indicates an increase in investor support for the new trend direction.

This combination of factors suggests the US dollar is developing a trend change with an initial upside target of $0.815. Above this is a target near $0.835 with the potential to retest highs near $0.865. The dominant feature of the US dollar index is the consistent volatility and the speed of change. In six months the US Dollar Index fell from $0.885 to $0.755. It also took six months in 2009 to rise from $0.74.5 to $0.885. This behavior suggests the potential for the US Dollar Index to reach near $0.88 around May 2011. Dollar volatility is here to stay and investors and business need to develop strategies to deal with US dollar strength.

Daryl Guppy is a well-known international financial technical analysis expert

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