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Technical Take: Currency Corner


The currency markets are the biggest in the world and therefore critical in an overall macroeconomic view and trading strategy.

With the Dollar Index on the brink of breaking to new yearly lows, I thought it would be a good time to check out some of the technical setups in the currency markets.

As you can see in the below long term chart of the Dollar Index, it is sitting right on top of huge long term support. Unfortunately, this 80 level support coincides with the neckline of a very large head and shoulders topping pattern. A significant break of this level would project down to the 40 level for the Dollar Index. In other words, the dollar would be cut in half versus the basket of currencies. The early 2005 low is 80.48 and breaking that level would mean new 10+ year lows. This is not good.

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So if the U.S. Dollar Index is breaking to new lows, where can we park some cash to hide? One recent beneficiary of the U.S. dollar weakness as well as commodity strength has been the Australian Dollar. I have been bullish on the AUD/USD cross since late last year as it started to close above the 0.78 level, as that opened the door to close above 0.80, which is a breakout of the long term pennant formation. This continuation pattern projects to above 1.00 for the cross and therefore I think it is safe to say we will see the Aussie Dollar be on par with the US Dollar within the next 3-5 years. This is a great currency to own if you believe in the long term bullish commodity trade, and pullbacks into the 0.80 level should be good risk/reward setups for long positions in the Aussie Dollar.

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The British Pound is another beneficiary of the recent dollar weakness as this cross is now at highs not seen in over 25 years. Recently, the Pound has convincingly closed above the $2 level, which should now serve as near term support. Pullbacks to this $2 level should provide good setups for long positions.

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Like the Pound, the Euro is breaking out to fresh new highs against the U.S. Dollar. The Euro has greatly benefited from central banks diversifying away from dollar reserves, and it looks like the $1.40 level is the next stop. The $1.35 level should provide solid near term support, and this new breakout at the $1.37 level should create added demand for the Euro.

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The Japanese Yen has been in focus this year as a primary source of liquidity for the markets. Investors are able to borrow Yen at extremely low interest rates and then buy higher-yielding currencies. This swap out of Yen has kept pressure on the currency and helped fuel the worldwide liquidity boom. However, the Yen is now at an interesting level and started to show early signs of some stabilization. The Yen rallied from near these levels earlier this year, sparking fear of the Yen carry trade unwinding and sending equity markets sharply lower in late February and early March. Therefore we need to keep an eye on the Yen at these levels, most importantly the 0.8250 level, which was the previous yearly low as well as just below the current 50 day moving average. Watch out for Yen strength above 0.830 as it could be an important clue to another impending equity market peak.

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Last but definitely not least I want to mention one market that will definitely benefit from continued U.S. Dollar weakness. Gold. As you can see in the below chart of the Gold futures contract, the commodity has found support in the $640-650 range (which also coincides with the 200 day moving average) as well as traded back above the near term downtrend line. Gold is setting up nicely for a solid buy signal and upside range expansion. I would like to see it close above the 50 day moving average here to confirm the start of a new uptrend. This would not bode well for the U.S. Dollar and certainly would be interesting for the world markets if this buy signal in Gold happened to coincide with a breakdown of the Dollar Index at that important 80 level.

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The currency markets are the biggest in the world and therefore critical in an overall macroeconomic view and trading strategy. Make sure to pay attention to important technical levels because the ramifications of currency moves will be felt in all markets. Happy trading!
No positions in stocks mentioned.
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