Will Fed's "Recovery" Bolsters Dollar
Fundamentals
The Dollar Index has seen very quiet sessions the past few days, following the directionless days in the equity markets. The currency did get a boost from the Fed yesterday, when the central bank used the word "recovery" for the first time. This suggests that both the Fed and the US government may take steps to slowly wean the economy off of the stimulus packages. This could result in a decrease in liquidity, decreasing the money supply. The long-term direction of the Dollar may ultimately be determined by two factors: interest rates and government spending. The greenback is still at a major disadvantage against higher-yielding currencies, and has found itself on the short end of carry trades. Increasing rates may aid in further cooling of selling pressure. If the US government does see a recovery taking place, some of President Obama's stimulus packages could be reined-in. Even if there is no decrease to the government's voracious appetite, the recovery could give the treasury time to find more efficient ways to put taxpayers' money to work. The strong showing in the most recent treasury auctions could be a sign that talks of diversification away from the Dollar by other governments may be more rhetoric than practice, but time will tell whether this is an anomaly or a trend.
Despite the previously mentioned factors, the Dollar is not without risk. As previously alluded to, low interest rates could cause the Dollar to quickly lose favor with investors and result in pressure from new carry trades. Also, if the Fed is not aggressive enough to raise rates when the time comes, inflation could be a major concern and would likely result in lowered demand for Dollar-based investments. The Dollar could also face pressure if the economy begins to cool, causing the Fed to maintain current policies.
Trading Ideas
The fundamental outlook for the Dollar Index has improved, hinting that prices may move high or stabilize, but there is also downside risk for the currency. Technically, the chart shows price edging toward resistance, so some traders may wish to keep an eye on these technical levels before taking action. For these reasons, some traders may wish to take on a bullish to neutral strategy, such as a bull put spread. One such spread would involve selling the March 77 put and buying the March 76 put at a credit of 0.20, or $200. The maximum profit on the spread would be the initial credit, and the max loss 0.80, or $800.
Technicals
Turning to the chart, we see the March Dollar Index breaking the relative high close of 78.61 on December 22nd. The contract is now entering an area of heavy congestion on the chart, which may act as a stumbling block, technically. The 79.50 and 80.00 levels are the next areas of resistance. A breakout above 80.00 may have a positive psychological impact on traders, in addition to crossing a technical hurdle. Failure to cross these resistance levels can be seen as a setback for traders and could cause the market to trade sideways or reverse. The RSI is nearing overbought levels, which can put some pressure on prices.
Rob Kurzatkowski, Senior Commodity Analyst
