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Summary
- The USD Index (DXY) has rallied to a new YTD high in the past week.
- This rally is pausing ahead of 107, which is also the 2023 high.
- The RSI for the USD index recently indicated the DXY was overbought and is now starting to unwind.
Market Implications
- We think the DXY is due a downside correction and like scaling into a tactical short USD position.
USD Has Traded Sharply Higher This Quarter
The USD has been on a tear since the end of Q3/beginning of Q4.
Since bottoming out on 27 September, when it closed very near 100, the DXY has risen over 6%. It closed last week at a new YTD high near 107, the 2023 high (Chart 1).
Higher US Yields Have Been a Critical Driver of USD Strength
The most notable driver of USD strength this quarter has been the sharp rise in US yields, which have spiked across the curve. The 2-year US Treasury yield has risen ~65bps so far in Q4 (Chart 2).
There has been a similar spike in the US 10-year yield (Chart 3).
Trump Factor Has Also Lifted USD
In addition to rising US yields, the increasing anticipation ahead of the eventual Trump victory in the US presidential election added impetus to the Q4 USD rally.
In the weeks before the election, the expectation was that a Trump presidency, which would entail hefty tariffs on many of the US’s most important trading partners and material fiscal stimulus, would lead to higher US inflation and relative US economic outperformance.
Now that the election result is known, and that the Republicans control not only the White House but also both houses of Congress, the market’s initial knee-jerk reaction was to bid up the USD.
Since the close of business on 5 November, the DXY is up about 3%.
USD Bullishness May Be Getting Ahead of Itself
In a piece earlier this week, our Macro Hive G10 FX team argued markets have been too keen to price perfection for Trump policies, and that Trump’s economic policies could hit road bumps.
Markets expect a large fiscal stimulus (mainly through tax cuts) to boost growth.
And, while this may yet happen, given the slender majorities in Congress and the lengthy approval process any new stimulus will probably face, the market may be getting ahead of itself in expecting additional near-term USD upside momentum.
It may also take longer than expected to enact the tariffs that Trump spoke about on the campaign trail.
As a result, the market’s exuberant USD buying looks like it is running out of steam.
The old market adage – ‘buy-the-rumour, sell-the-fact’ – may very well be at play in the coming days and weeks.
DXY Is Starting to Look Toppy
From a technical perspective, there are signs that USD upside momentum is ebbing.
The recent rally, which has taken the DXY to a new YTD high, is pausing ahead of 107. The level is interesting because it also was where the DXY rally halted in October 2023. Back then, the DXY sold off by 5.5% into year-end.
And while history does not always necessarily repeat itself, it is reasonable to conclude that this 107 level will serve as a strong resistance, and that further DXY gains will be difficult.
The recent dollar rally has also seen the RSI reading for the DXY move above 70, near which it still hovers.
Regular readers will know that the RSI is an important tool used by technical analysts, and that the ‘30/70 rule’ is an effective (and widely used) guide for determining whether a security is overbought or oversold.
The DXY’s RSI printed above 70 in recent weeks, therefore flagging the index as overbought.
And, although it has been sticky near that level, the RSI is starting to unwind (Chart 4)
Therefore, given that the 107 resistance level coincides with the DXY unwinding its overbought RSI, we think that from a technical perspective the dollar is due a downside correction.
When combined with the market getting ahead of itself on the impact and magnitude of the Trump presidency, we like scaling into a tactical short USD position.
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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)