Rakuten Securities Australia (RSA) 2018 Outlook: The Dollar

Coming into 2017, investors had high hopes for the US Dollar. It was up 3.5% in 2016, with all the gains coming from a strong rally that began at the start of November and culminated in the Fed’s hike on December 15^th. It was then flat for the rest of the year. Investors were hopeful the consolidation after the huge rally from 2014 was finally over. The double top at 100.4 was finally broken and the dollar was ready for the next leg up. The Economist released their edition titled “The Mighty Dollar” on December 3^rd. Speculators had amassed their largest long position since 2015 according to CoT data. Everyone and their pet rabbit was long dollars coming into 2017.

We all remember what happened next. The dollar had an intraday high of 103.82 on the 2^nd trading day of 2017 and did not stop falling until the 3^rd quarter of the year. The decline reached its nadir on September 8^th when the dollar printed an intraday low of 91.03; a peak to trough decline of 12.32%.

It recovered slightly into the end of the year to finish at a 9.6% loss.

Coming into 2018, the situation seems to be the exact opposite. Everyone is forecasting the dollar to head much lower in 2018 and the general sentiment is very negative. Investors are falling over themselves to add to short positions or get short if they are not already.

We anticipate that the dollar is very likely to surprise everyone this year with a strong performance. Being short dollars is a very one-sided trade and those rarely work out. Borrowing from the famous Bob Farrell, “When all the experts and forecasts agree, something else is going to happen”. We present our case for a strong dollar in 2018 below, looking at it from a technical, fundamental and sentiment perspective.

This column was produced by Oliver Sabau from Rakuten Securities Australia. Rakuten Securities Australia is backed by the global expertise of Rakuten Securities Inc., which is one of the largest retail FX brokers in the world by volume and is a subsidiary of Rakuten Inc. Rakuten Securities Australia is an ASIC regulated broker and delivers a fast execution environment, supported by strong liquidity, fixed tight spreads and no commission, together with all the necessary analytical tools for a trader to make trading decisions and execute on a daily basis.

The Technical Picture

While the dollar (in this analysis we use the DXY index as a proxy for the dollar) did have a large fall in 2017, it is still firmly in an uptrend. The support trendline put in place by connecting the lows from the middle of 2011 and the middle of 2014 has not been tested. This line is coming in around 87.0 at the moment so the price is above this level and would have to fall another roughly 3% to test it. A break below this trendline will invalidate our claim that the dollar will resume its bull market in 2018.

The dollar broke below important support several weeks ago, around 91 – 91.40, defined by the 50% Fibonacci retracement from the 2014 lows to the 2017 highs and the low from September 2017. As the break was not quickly reversed, it must be considered as a genuine downside break. This was proven in the strong follow through to the downside.

From here, we see the dollar as having 3 paths forward. The first is a ‘V’ shaped recovery where the dollar bounces aggressively. It bounced perfectly off the 61.8% Fibonacci retracement from the 2014 lows to the 2017 highs. Just below this level is the 50% Fibonacci retracement from the 2011 lows to the 2017 highs which was also successfully tested a few weeks ago. These 2 levels coinciding provides good support for the dollar. The bounce will have to clear previous support in the 91 – 91.40 area to be considered anything more than a counter-trend rebound.

The second is a consolidation pattern that forms a base for the dollar. The most likely pattern is a range where the price will oscillate between 88.30 and 91 for a few more weeks before a catalyst appears that pushes the dollar higher. This will have to break overhead resistance at 91.40 and channel resistance around the same level to be considered more than a counter-trend rebound.

The third is a sharp plunge below support at 88.30 to the trendline.

We don’t have an opinion on which of the 3 is most likely to occur. The Fibonacci support lines, the channel resistance, and trendline support all intersect later in the year, around July, so we will have a resolution by then at the latest. What we would like to see is the third option. This will allow us to build a long position at a lower price than if a low has already been put in place for the dollar. Sharp, vertical plunges are also good indicators of the end of a trend.

The Fundamental Picture

The biggest driving force of the EUR/USD exchange rate over time, which in turn is the biggest component of the dollar index, is the relative strength of the European stock market versus the US stock markets. We will use the ETFs EZU and SPY to illustrate our point. While US stocks weakened relative to EU stocks beginning in 2017, this underperformance ended in May and then had a double bottom in October before US stocks resumed their outperformance of EU stocks.

The dollar, however, continued to fall. As US stocks continue to outperform, it will put irresistible upward pressure on the dollar as investors buy dollars to invest in the US stock market. The divergence between the DXY (blue line) and SPY/EZU (red line) will not last and it will force the dollar to appreciate to “catch up”.

Our outlook and prediction

We feel that the dollar is poised for a strong rally to resume the uptrend that began in 2011. Technically, it will either rise quickly, continue to base by range trading for a few more weeks or it will decline further and find support on the trendline. From a profit perspective, we would prefer a dollar decline to the trendline as it will allow us to buy dollars at a lower price but are cognizant that a recovery may already be underway.

Momentum, after having been stretched to the downside, and printing some of the lowest readings in many years (a decade in the case of RSI!) has started rising and are showing positive divergence with the price. The new low in the dollar has not been confirmed by the momentum indicators.

The fundamental drivers all suggest the dollar should be much higher and if the outperformance of US stocks relative to their EU counterparts continues, it should force the dollar higher. Ditto for the yield spreads on the 2 year and 10-year notes.

The sentiment is the most supportive it has been for the dollar since the beginning of the rally in 2014. The huge long positions in the Euro will cause acceleration to the downside when the Euro begins to crack as speculators must liquidate these positions.

Our near-term outlook is that a bounce may already be underway but this view may prove to be too sanguine so we are ready for a trend-ending spike down to the support trendline. Whichever outcome prevails, first resistance lies at previous support around 91.40. This is the first level that must be broken for any rally to be something more than just a counter-trend rebound

95 is seen as the next crucial level.

A rise above this level will clear the 50 (pink line), 100 (blue line) and 200 (green line) week moving averages, as well as break out of the falling channel that contained any rebounds in the dollar during 2017. This is also the level at which the counter-trend rebound from the September 2017 lows ended.

If the price does decline further to test the support trendline, this level will roughly coincide with the 50% Fibonacci retracement from the 2017 highs.

All in all, a crucial level.

A break above 95 will see a test of 100 all but confirmed. A strong rally will see that level tested this year while a weaker rally will see it tested in 2019.

Rakuten Securities Australia offers ultra-low spreads that are priced according to Japanese Retail FX pricing. Rakuten Securities Australia charges no commission and the spreads are fixed for 95% of the normal trading hours. The other 5% of the time is during periods of low liquidity such as data releases, market roll-over and holidays.