As we are heading towards the weekend, the dollar is beginning to come back to life again. A lot of investors and analysts were left scratching their heads after Wednesday’s dramatic moves in the markets as dollar reversed earlier gains to head lower despite the release of stronger-than-expected CPI inflation data. The greenback extended its losses on Thursday thanks to momentum selling, before bouncing back today.

While the selling gathered pace this week, market participants are fast running out of reasons to further press the dollar. After all, this week’s inflation data has further fuelled expectations that the Federal Reserve will raise rates more aggressively this year than had been expected. What’s more, the dollar looks severely oversold – at least in the short-term, anyway – which means even the bears might be helping to aid its recovery by means of profit-taking.

Granted, the bears could argue that the dollar is in a longer term downward trend because of rising demand for foreign currencies as the likes of the European Central Bank and the Bank of Japan begin preparing to normalise their respective monetary policies. Furthermore, they could point to the fact that the Fed’s projected rate hikes have been well-documented and so priced in. In addition, the dollar’s woes may also reflect in part concerns over the ballooning US debt levels and some loss of trust in the government.

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However, taking everything into consideration, we think that the dollar looks undervalued at these levels and that it could make a comeback in the coming weeks, if not earlier. But do need to see a clear bottom pattern emerge to confirm the reversal.

In fact, the Dollar Index has again reached a massive area of support around 88.50. This level was major resistance back in the years 2008, 2009, 2010 and 2014, before the lift off late in 2014. Given the importance of this level, and the recent improvement in US macro data, we are now on the lookout for a potential bottom in the dollar. If the DXY does start to go back above last week’s low and hold there then the bears might get in trouble. For confirmation, I would like the DXY to clear previous support and resistance area around 91.05-91.92 before turning decisively bullish on the dollar. But the early signs are promising. Obviously if the DXY fails to turnaround here, then we would have to put out bullish views on hold again.

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