 A dramatic breakout week for the greenback
by Kevin Pendley
After months of being dragged in the dirt, having sand kicked in its face and being slapped around by the global community like the proverbial red-headed step child, the once mighty U.S. dollar finally flexed its muscles during the first full trading week of August. The greenback stormed to 7-month highs against the Japanese yen and was on target for the highest weekly close against the euro since March.
It would be wonderful to report back to all of you that the U.S. dollar resumed its proper position of strength amid a worldwide cascade of acclaim toward Uncle Sam's economy, the marvel of American corporate ingenuity, the attractiveness of our equity assets. Alas, the news here on the home front isn't all that hot. In fact, weekly unemployment claims are at the highest level in more than six years. But there is a brooding sense around the world that things aren't all that great anywhere else, either. Hey, any port in a storm, right?
Turns out, this was a big week for central bankers to hunker down in smoke-filled rooms, pour over reams of economic data and then dramatically announce to the world that they will do … nothing. Here in the United States, the Federal Open Market Committee (FOMC) met Tuesday, shifted a few words around in their statement to the waiting denizens of breathless investors, then left the Fed funds rate unchanged at 2.0%. In the United Kingdom, the Bank of England (BOE) left rates at 5.00%, just like everyone said they would, and the inflation-fighting powers that be at the European Central Bank (ECB) cowered back from taking a hard liner stance on surging prices and left rates steady at 4.25%, with their leader Jean-Claude Trichet saying that economic growth risks were appearing on the horizon. And here I always heard that the ECB's only mandate was to stave off dreadful inflation. It's a tricky tightrope to hope that slowing growth will curb price pressures, but it's a treacherous path that policy makers everywhere are trying to navigate.
So, what does it all mean for foreign exchange markets and the U.S. dollar? As regular readers of this column know well, I have been pushing for short euro/long dollar trades since April and I continue to prefer that stance, even with the big move that was carved out this week. There is a great double top on long-term euro charts on the highs and the euro/dollar pair is moving toward a test of key support near 1.5300. It might take some time to peck away at that support, but if it happens, a swift extension of the decline in the euro should take place. I keep hearing a price target of 1.4400 among FX traders, and that often has a way of becoming a self-fulfilling prophecy. By the way, 1.4400 is roughly equivalent to the 2008 lows set back in January. If we have truly turned around the battleship on this trend, 1.4400 will only be a weigh station on the bumpy journey down to 1.3500. If you really want to get long-term creative on the euro top, 1.3157 equals a 38.2% Fibonacci retracement of the entire 7 ½-year bull market explosion in the euro. That might sound extreme, but it's a realistic long-term goal for a dollar bull.
Although I tend to focus on the euro/dollar because it commands the most volume and is the most entertaining FX market to trade, I would be remiss not to spend a little time on the week's impressive upside breakout in both the dollar/yen pair and also on dollar index futures. There was a strong resistance zone in the dollar/yen market near 108.50, and once the pair popped through that resistance, the market really took flight. There is a risk here of a little double top on daily charts that bears watching in coming days, but as long as 108.50 now holds up as support on pullbacks, then it will validate the upside breakout. The obvious short-term target for the move is 110, which was challenged on this week's break. Not only is 110 a nice round figure, but it also corresponds with a 50% retracement target of the June 2007-March 2008 bear market collapse in the U.S. dollar vs. the yen. If the dollar can push through 110 in the days ahead, then the next logical target is at 113.45, then 118. Any decisive push through 113.45 would suggest that the bear market move is over and that upside targets toward 124.15 are back on the radar screen.
As for dollar index futures, that derivative market--which combines a basket of global currencies against the greenback-shot to the highest point since late February and is on track to close above the 40-week moving average, which has not happened in more than two years. For those of you who lean toward trading futures and options products, my upside objective on the long dollar index contract is just shy of 80 as long as we can convert 74 into support on the weeks ahead.
Updating our current trade recommendations, once we made it through the U.S. employment report without too much volatility, I reinstated our short euro/dollar trade on last Friday's close (Aug 1). In addition, our short euro/krone trade rallied to the trigger point, so we are now in that position as well.
FX COLUMN TRADE CONCEPT RECAP
DATE CONCEPT PRICE THEN/NOW PROFIT/LOSS COMMENT
4/24/08 Short euro/dollar entered @ 1.5682 +0.52% stopped out at 1.5600
5/01/08 Short euro/yen entered @ 161.50 +0.12% stopped out at 161.30
5/08/08 Short euro/Canada entered @ 1.5680 +1.46% profit taken @ 1.5450
5/15/08 Short euro/yen entered @ 162.40 -0.36% stopped out at 163.01
5/29/08 Short euro/dollar entered @ 1.5525 -0.55% stopped out at 1.5610
6/10/08 Short euro/dollar entered @ 1.5682 +0.99% stopped out @ 1.5610
6/19/08 Short Aussie/dollar entered @ 0.9600 -0.49% stopped out @ 0.9670
7/03/08 Short euro/dollar entered @ 1.5750 -0.64% stopped out @ 1.5851
7/18/08 Short euro/dollar entered @ 1.5885 +1.94% profit taken @ 1.5576
7/18/08 Short euro/sterling entered @ 0.7920 +0.78% profit taken @ 0.7858
7/31/08 Short euro/krone entered @ 8.0400/7.9998 +0.50% stops @ 8.0455
8/01/08 Short euro/dollar entered @ 1.5563/1.5369 +1.24% stops @ 1.5501
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