Dollar Rally

There’s life in the old dog yet. Some observers have pointed to overbought conditions as the dollar grinds ever-higher. The relative strength index (RSI) for the dollar index currently has a reading of 86.6. The index ranges between 0-100 and indicates the price position of the underlying with reference to a specified number of recent periods. Technicians often draw 30-70 lines to make the point that even healthy trends tend to lose followers when the RSI crosses the line. Typically, a move into overbought territory above 70 or oversold territory below 30 is enough to frighten trend followers. But seasoned technicians also know that during overstretched market conditions, some of the biggest and best moves occur. That certainly seems to be the case for the dollar at present, which is “suffering” from the market’s assumption that Fed tightening will come sooner-rather-than-later.
Our chart du jour shows the almost parabolic ascent of the dollar index (black line) driving the RSI (lower panel) to highs witnessed only in May of both 2010 and 2012 during the last five years. Arguably the build-up was longer or faster under either scenario and could mean the nascent bullish phase for the dollar has plenty of life left.

Chart – Dollar driven by acceleration of views on timing over Fed rate-rise

(click to enlarge)

Also added to the chart is a way of looking at the market’s view on timing of monetary tightening. Here we simply adopted Eurodollar calendar spreads to gauge the gradient of the curve for next year (yellow line) and 2016 (mauve line). Currently the dollar seems bid because of the diminishing view that the Fed will be able to maintain its ultra-low interest rate stance. The 2015 yield curve has jumped to 87bps while the 2016 yield curve, although higher at an outright 110bps, hardly seems to be responding to growing fears for tightening. That may largely be because the money market is predicting three-month yields will stand at 2.25% by the end of 2016 and the curve may have a more than 1% gradient. In other words, plenty is built in to traders’ expectations for 2016. And with large block trades hitting the shorter-end of the Eurodollar market possibly in relation to the sudden departure of Bill Gross from Pimco, fears are self-feeding over a panicky exit from low interest rates. In turn that’s providing further fuel for the dollar. Dollar bulls may want to keep a close eye on the relative tightening expectations that now could be a necessary condition if the bull market is to carry on.

About Andrew Wilkinson 1023 Articles

Affiliation: Interactive Brokers

Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.

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