US Dollar: Technical Support Levels May Finally Force The Rally To Pause

The US dollar rally showed few signs of exhaustion on Monday, as the currency rocketed higher across the majors despite there being absolutely no economic data on hand. However, there are technical indications that the greenback could be due for a pause. Indeed, the US Dollar Index ran into falling trendline resistance today, which connects the late 2005 – 2007 highs, while daily RSI is well into overbought territory. Furthermore, both EUR/USD and GBP/USD have hit critical support levels, with the former testing the late 2007/early 2008 highs near 1.4880/1.4900 while the latter probes a rising trendline dating back to early 2002. These points all mark the proverbial ‘line in the sand’ for the greenback, and where the currency goes from here will be largely indicative of the longer-term trend.

Meanwhile, there is little in the way of event risk for the US dollar until Wednesday, when US import prices and retail sales will hit the wires. Advance retail sales could prove to be a bit more important for forex market price action, as the headline index is anticipated to rise slightly by 0.1 percent. However, as I mentioned in the 5 Key Events for the Forex Market This Week, there’s some potential for this reading to be disappointing as average gasoline prices fell back from above $4/gallon. Wait, you may be thinking, isn’t this positive for consumers? Yes, but since this index is not adjusted for inflation, the gasoline station component has been by far the biggest gainer in recent months, pushing the overall index higher. Thus, the recent drop in prices should, theoretically, weigh on Advance Retail Sales this time around. My fundamental bias for the US dollar on Wednesday: bearish. For more on US dollar event risk this week, checkout our Forex Trading Weekly Forecast.

Australian Dollar Hits 6+ Month Low As Gold Plummets More Than $35/oz

Currencies like the Australian dollar, New Zealand dollar, and Canadian dollar all remained weak on Monday thanks to softer commodity prices, but the most notable move by far was in gold, as the metal plummeted more than $35/oz. There has been speculation that these moves are the result of deleveraging, as gold-mining companies have reportedly reduced hedging by cutting back on their forward sales in the second quarter to the lowest since 1987. As Quantitative Analyst David Rodriguez said in his special report on forex correlations, “the outlook for the Australian dollar may very well depend on gold prices as well as the usual host of factors,” and as long as gold continues to decline, the risks for the Aussie will remain to the downside. Meanwhile, Canadian housing data was broadly disappointing, as housing starts slowed to 186.5K – the lowest since December 2007 – while new-home prices slowed to a 3.5 percent annual pace in June, marking the smallest gain since March 2002. The news adds to the pile of indicators pointing toward a further slowdown in the Canadian economy, as last week’s releases of Ivey PMI and employment levels all reflected deteriorating conditions. Likewise, in New Zealand, Quotable Value reported a 2.2 percent drop in house prices in July from a year earlier, which is the first negative reading since record-keeping began in early 2005. Later this week, New Zealand retail sales excluding inflation are anticipated to have dropped by a whopping 1.8 percent in Q2, the worst drop since records began in 1995. Clearly, restrictive monetary policy by the Reserve Bank of New Zealand has taken its toll on the economy, and the collapse in domestic demand is likely to lead the central bank to cut rates further from their current level of 8.00 percent.

Euro Struggles To Hold Above the 2007 Highs

As of Monday’s NY close, the Euro was still testing former resistance at the 2007 highs near 1.4880/1.4900 as dollar bulls weigh the currency down. The drop is in line with the shift in interest rate expectations that we saw take place last week following the European Central Bank’s rate decision, as overnight index swaps are now pricing in almost 30bps worth of rate cuts within the next 12 months. Less than a month ago on July 21, overnight index swaps were pricing in 40bps worth of hikes. However, the release of Euro-zone GDP on Thursday will go a long way to confirm or dispel fears of an all-out economic contraction in Q2, as these interest rate expectations are based primarily on the fact that ECB President Trichet put the spotlight on the downside risks for growth in the region. Until then, though, traders should keep an eye on immediate support levels, as a EUR/USD break below the 2007 highs will likely target 1.4680/1.4700.

British Pound Hinges On UK Interest Rate Outlook

The British pound fell throughout the US trading session as UK producer prices rose less than expected in July. Nevertheless, the PPI-output index still rose at the fastest pace since record-keeping began in 1986, suggesting that inflation pressures have yet to abate. Like the Euro at the NY close, the British pound was testing key support at a rising trendline starting from the 2002 lows near 1.9050/65. A break below this point would certainly be a bearish signal, but the 200 SMA on the weekly GBP/USD charts at 1.9022 may be a better point to watch. In fact, since breaking above the 200 SMA in June 2002, the level has served as solid support following multiple tests in August 2002, November/December 2005, January 2006, and March 2006. If GBP/USD breaks below this point, though, it will essentially signal that the pair topped out back in November 2007. From a fundamental perspective, releases on Tuesday and Wednesday will be crucial for GBP/USD, as UK CPI will hit the wires on Tuesday and on Wednesday, the BOE’s Quarterly Inflation Report will be released, though the latter is likely to be more important since forecasts for inflation and growth may be revised.

Japanese Yen Second Only To The Greenback

While the Japanese yen did not beat out the US dollar today, the low-yielder did gain across the rest of the majors on Monday as deleveraging remains a key theme in the markets. However, according to the latest forex correlations report, the once-famous correlation between the USD/JPY, G10 carry trade, ad the DJIA has since faded. That said, there is potential for the Japanese yen crosses to plummet, with the exception of USD/JPY. Indeed, USD/JPY is trading on the whims of the greenback and will likely continue to do so within the next week of trading.

Terri Belkas is a Currency Strategist at FXCM.