The USD’s Fragile Footing

Three weeks ago, we noted that ‘King Dollar’ may take a breather until December. back then analyzed the three main drivers of the greenback’s impressive post-election rally: expectations for an infrastructure spending boom under President Trump, a more hawkish path for interest rates from the Federal Reserve and the rise of populism/nationalism in Europe. We concluded:

we wouldn’t be surprised to see the US dollar pull back over the latter half of the November before the longer-term bullish trend can reassert itself.

As you may have noticed, we’re December has come and the dollar has definitely taken a breather. In fact, the US Dollar Index fell back to test the key 100.00 level on Monday, off more than 2% from its intraday highs. While the situation is playing out as expected on a technical basis, the fundamental picture is more ambiguous.

Specifically, last weekend’s “no” vote on the Italian constitutional referendum has not been a bearish catalyst for EUR/USD, which makes up the majority of the dollar index. Instead, the world’s most widely traded currency pair has rallied nearly 300 pips off its lows to hit a three-week high. With one of the three “legs” of the USD-bullish “stool” giving way, the anticipated rally is on increasingly fragile footing. If, for instance, the Fed fails to lay out an aggressive path for projected 2017 interest-rate hikes in its meeting next week, the Dollar Index could be vulnerable to an even deeper pullback.

Watch This Level

As always, the price action will guide our trading decisions. The key level to watch on the dollar index is the century mark (100.00). As long as USD holds above that critical level of previous resistance-turned-support, we’re inclined to give the recent uptrend the benefit of the doubt. But if the dollar index drops back below 100.00, perhaps on the back of a less-hawkish-than-expected FOMC outlook next week, a deeper pullback toward the mid- or lower-90s could be next.

If that scenario plays out, we would look for the currencies that have shown relative strength post election (namely the pound and Canadian dollar) to see the strongest rallies against the greenback, though the beaten-down European currencies (euro and Swiss franc) could also recover nicely.

U.S. Dollar Index

Source: Stockcharts.com

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