We mentioned earlier that today would all be about levels, there is limited economic data coming out of the US and no Fed speakers, which could leave the market free to focus on the technicals. One level that is sticking out like a sore thumb is 80.38 - the 200-day moving average in the US Dollar Index. We crossed above this level earlier today as both EUR/USD and GBP/USD came under sharp downside pressure.
Figure 1: 
Source: Bloomberg, please note that these prices are not offered by FOREX.com
The question now is: can the greenback sustain upward momentum? We have been here before, the strong dollar was supposed to be the big theme of 2014, but 5 months in and we are still waiting. While we don’t have a crystal ball at hand, we thought it best to lay out the case both for and against a move higher in the dollar in the medium-term:
For a stronger dollar:
- Economic data is slowly starting to turn; durable goods orders were stronger than expected for April, which can be symbolic of a deeper recovery.
- Q2 GDP is expected to bounce back after a dismal start to the year, due to the weather effect.
- Inflation is starting to pick up, core CPI has started to pick up strongly, and is only 0.2% away from the Fed’s preferred rate of 2%.
- If inflation starts to pick up, then Treasury yields could follow suit. If yields start to pick up then this could add fuel to the USD’s fire.
- The EUR and GBP could come under pressure over the summer, which may add to the dollar’s attractions. The EUR could come under pressure if the ECB embarks on an easing cycle next month, and the UK economy looks like it may be topping, which could limit GBP upside from here.
Against a stronger dollar:
- Although there may be fundamental reasons for US Treasury yields to rise, they have been stubbornly low in May and remain below 2.5%. The risk is that yields continue to fall. Yields and the dollar tend to move in the same direction, so if yields can’t push higher this could limit USD upside.
- Some key members of the Fed, including Chairwoman Janet Yellen, are uber-dovish and although the Fed has started tapering, tightening seems a long way off.
- While the US economy is expected to pick up in Q2, in the short term, the second reading of Q1 GDP, released on Thursday, is expected to be revised lower to negative territory, which could sour sentiment towards the USD in the short term.
- Even if the ECB does ease at its meeting next week, if it does not indicate further accommodative action then we could see a rebound in the single currency.
In my view, I am still holding out for the dollar to push higher for the second half of this year. The most compelling reason to me is inflation – there are signs that price pressures are building in the US, which could trigger a sharp reversal in Treasury yields and boost the dollar.
Although this is all theoretical at this stage, I continue to think that Treasury yields are too low, and can’t stay sub 3% forever (famous last words!). While EUR/USD is a bit risky leading up to the ECB meeting next week, the dollar could make headway against GBP and CHF.
One to watch: USDCHF:
This cross has upside potential if we get a daily close above 0.8989 – the 200-day sma and the 61.8% Fib retracement of the February – March sell off. We expect this important level to give way, which could lead to further gains. The daily MACD is above the zero line, which suggests that momentum is to the upside.
Above 0.8989 opens the way to 0.9082 – the February 3rd high, and then to 0.9156 – the high from January 21st. In the short term, this pair is starting to look overbought, so there could be some light selling pressure. Support lies at 0.8920-30, then 0.8869 – the 38.2% retracement of the latest recovery.
Figure 2:
Source: FOREX.com
Takeaway:
• A daily close above the 200-day sma would be a bullish technical development for the greenback.
- If Treasury yields start to move higher this could signal further gains.
- The fundamental picture is starting to get more dollar-positive, as the US economy picks up speed in Q2.
- However, Q1 GDP is expected to be revised lower, which could trigger some short-term downside in the buck.
- We think the dollar could perform well against the GBP and CHF in the near term, the outlook for the EUR could depend on next week’s ECB meeting.