Was the Dollar's Demise Greatly Exaggerated?
Fundamentals
Just when it looked liked the recent rally in the U.S. Dollar had run its course, the greenback has soared to 2 ½ week highs in the March Dollar Index futures, as traders move back into their "risk averse" mode. Among the major factors bringing traders back into the U.S. buck are the continuing actions out of China to help curtail its rapid economic growth, including the Bank of China telling banks to restrict lending for the remainder of January. This comes on top of Chinese officials already raising bank reserve requirements and hiking benchmark interest rates in order to prevent a potential "asset bubble" from forming in the world's most populous nation. In Europe, European Central Bank (ECB) officials seem to be playing hardball with Greece, whose budget problems have caused rating agencies to downgrade the country's debt. Several members of the ECB's executive board, including Juergen Stark and ECB President Jean-Claude Trichet, have commented that the European bank will not adjust its policies or rules to help Greece or other member countries experiencing budgetary woes. These events, along with the victory by Republican Scott Brown in the special election to fill the vacant Senate seat in Massachusetts, have drawn traders to the U.S. Dollar. This Dollar strength is putting pressure on speculators who are holding so called "carry-trades" in which investors borrow in a low yielding currency (U.S. Dollar or Japanese Yen) and invest the proceeds in higher yielding currencies or investments ( Australian Dollar, Brazilian Real and equities). Given the size and leverage of these positions, traders must unwind these positions in greater amounts as the Dollar and or Yen rise, causing a "snowball effect", which could lead to further gains in these currencies as margin calls are issued, which could cause further liquidation of these "carry-trades".
Trading Ideas
Given the fractured economic condition of several European Union member countries, most notably Greece, Italy, Spain, and Ireland, and much division on how to address the economic issues facing these countries, the Eurocurrency could remain under pressure. Traders looking for the Euro to continue to weaken vs. the U.S. Dollar may wish to investigate the purchase of bear put spreads. An example of this trade would be buying the March Euro 1.40 put and selling the March Euro 1.35 put. With March Euro trading at 1.4088 as of this writing, the spread could be purchased for about 130 ticks, or $1,625 per spread, not including commissions. The premium paid would be the maximum risk on the trade, with a potential profit of $6,250 minus the premium paid if March Euro's are trading below 1.3500 at option expiration in March.
Technicals
Looking at the daily chart for the March Dollar Index (DX), we notice that Wednesday's breakout above the 20-day moving average was met with strong buying interest, not only by short-term momentum traders, but also from liquidation buying by those short the Dollar. Also notice that during the Dollar's sell-off last week, we still failed to close below the 100-day moving average, which appears to signal that 3+ week down-move in the DX futures was nothing more than a correction in what may be the early stages of a sustained bull move for the Dollar. The 1-day RSI has also turned supportive, with a current reading of 62.71. The December 22nd highs of 78.77 look to be the next resistance point for the March DX contract, with support found at the 100-day moving average, currently near the 76.85 area.
Mike Zarembski, Senior Commodity Analyst
