US dollar breaks out

By David Morrison  |  24/04/2018 15:55

This article looks at the rally in the dollar as it breaks above resistance on rising bond yields and oil

Dollar jumps

On Monday evening the Dollar Index broke above 90.00. This level had held as resistance since the last week of January, excepting a brief false breakout at the end of Feb. The dollar’s move led to a corresponding break below support on the EURUSD around 1.2250. This is most clearly illustrated by a look at the daily chart (shown below) where a symmetrical triangle had been forming since the multi-year high of 1.2555 was hit in early February this year. The symmetrical triangle pattern builds as the market catches its breath during a trend. It is characterised by a succession of lower highs and higher lows as prices consolidate before the next significant move. Typically, a triangle is considered a continuation pattern which, given last year’s dollar sell-off, would suggest that the EURUSD was getting ready to break to the upside. However, that’s not always the case as can be seen here. The question now is whether this week’s move so far indicates that the weak dollar trend (which began at the beginning of last year) is coming to an end, or is a false breakout. If the latter, then we should expect to see the EURUSD bounce back to within the parameters of the triangle over the next few trading sessions. If it doesn’t then the first downside target is 1.2150 (the low from 1^st March) followed by a move down to around 1.2080 where there was some mild resistance at the beginning of this year.

10-year yield testing 3.00%

The dollar’s rally has come on the back of a sell-off in US Treasury bonds. The yield on the 10-year note (which moves in the opposite direction to the bond price) is testing resistance at 3.00% (it broke above here on Tuesday). Some analysts believe that a decisive break of this level will signal that the 35-year bull market in bonds is over and indicative of rising US borrowing costs going forward. This has significance for equity traders. Not only do higher interest rates act as a drag on the costs of companies doing business, but the rising ‘risk free’ return on fixed income means that investors will increasingly shift their exposure away from riskier equities.

Oil rally sparks inflation fears

We had a similar scare and move in bond yields back at the end of February following an unexpected spike in Average Hourly Earnings. There were fears that wage growth would feed through to a pick-up in inflation leading the Federal Reserve to tighten monetary policy faster than expected. These concerns subsided soon after as average earnings fell back towards trend. But this time round it seems that it is the ongoing pick-up in the oil price (WTI is trading just shy of $70 per barrel – its highest level since December 2014) that is raising investor concerns over the future path of inflation.

Trump tweet

What we do know for sure is that the Trump administration favours a weaker dollar for trade reasons. And it was only last week that the president tweeted that OPEC was pushing oil prices to “artificially” high levels, leading to a sharp sell-off in crude. That move was reversed quickly. But it has put investors on their guard over what Trump may do next.


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