G10 FX Weekly: DXY Starting to Bounce, but Anticipate Further Downside

Summary

• The USD Index (DXY) traded 3.5% lower last week – its worst week since November 2022.
• DXY is trading slightly higher this week, with the index down for six of the past nine weeks.
• A key DXY technical indicator, the RSI, is turning from being oversold.

Market Implications

• With the technicals turning, we think the DXY is due a corrective bounce.
• We prefer to fade any DXY bounce.

DXY Sliding Since January

Since topping out on 13 January, DXY has fallen a little under 6% (Chart 1).

Last week’s 3.5% decline was the worst week for the DXY since September 2022.

DXY Technicals Turning From Oversold

Due to the massive DXY sell off, the RSI printed below the 30 oversold threshold at ~26 earlier this week. The small DXY price bounce over the past day or two has lifted the RSI back above 30 (Chart 2).

Momentum Players Now Less Bullish USD

Last week’s CTAs bullish USD signals had weakened.

Most notably, EUR/USD flipped from modestly bearish to modestly bullish, GBP/USD shifted from modestly bearish to very bullish, and USD/JPY shifted to modestly bearish from modestly bullish (Chart 3).

This trend continued this week, with AUD/USD and NZD/USD flipping to modestly bullish from modestly bearish, and very bullish USD/CAD shifting to modestly bullish (Chart 4).

We think CTAs are out-of-sync with (and slow to react to) the USD trend-shift.

Momentum players were uniformly bullish the USD since late last year, which served them well into January.

With the USD sell-off since then, CTAs have been slow to shift positioning. We argue that back in January, one of the key drivers of the USD sell-off was crowded long positioning, as witnessed through CTA exposures.

Given the time taken for these crowded longs to be shaken out, it seems as if the CTAs have capitulated on longs just as a corrective bounce is imminent.

EUR/USD

EUR/USD’s weighting of 57.6% makes it the DXY’s biggest component.

As a result, the EUR/USD rally from ~1.0240 to ~1.0840 since mid-January has driven much of DXY downside (Chart 5).

Regarding the technical outlook, when the DXY became oversold, EUR/USD (unsurprisingly) concurrently became overbought (Chart 6).

Therefore, given the RSI has turned and is heading lower, we expect a downside correction in EUR/USD.

We Like to Fade Any DXY Bounce

Given the turn in technicals for the DXY (from oversold) and EUR/USD (from overbought), we think that there is potential for the former to correct higher and the latter to correct lower.

Adding that CTAs are flipping their positions at the least opportune time from bullish to bearish USD strengthens the notion the USD could have near-term upside. USD upside will be painful due to momentum players’ shifts.

Nonetheless, despite our expectation the greenback will move higher in the near term, we think this will only be a corrective move and one worth fading.

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