Weekend Analysis

U.S. Dollar 2006?

I'm back! It's been a couple of weeks since I last posted a chart analysis and because you've all been patient, I want to provide ya'll with a lil' extra sumtin' sumtin'. I've been doing a little research trying to figure out where the US dollar is headed for 2006. While I'll be the first to admit that I have absolutely no clue where the dollar will go, I've written down my thoughts on what I believe will be the main issues that will be driving the direction of the dollar. I thought it's a little bit long to be read online so I've provided it as a PDF download.

I've tried to make my thoughts easy to read and I've also thrown in some of my signature corny jokes (mainly to entertain myself). You can download it here: Pip Diddy's “Da Skinny on da Dollah fo' 06”

Back to the Show…

On Friday, it was announced that December non-farm payrolls rose 108,000. This was below the expected 200,000 gain. The dollar fell sharply on this worse than expected non-farm payrolls since the data fueled expectations that the Fed's cycle of interest-rate hikes would come to an end sooner rather than later.

The minutes from the latest FOMC meeting, released on Tuesday, also confirmed the softer tone of the statement from the December meeting. The FOMC believes the fed funds rate is very close to neutral, meaning a pause in the tightening cycle is in the works.

The minutes also showed that the FOMC is split regarding how much more the interest rate should be raised: “Views differed on how much further tightening might be required.” This means data in the coming months - especially inflation data - will be very important concerning when the FOMC will stop hiking rates.

The first indication of possible inflation in December will come this week, when producer prices (PPI) are released. The market consensus expects the PPI excl. energy and food will rise by 0.2% month-over-month (m/m). Anything higher would provide ammo for the Fed to continue to raise rates (dollar bullish), while a lower number would cause them to possibly think about stopping hikes even sooner (dollar bearish).

The coming week will also see a number of speeches from FOMC members that could possibly impact the market, as some clues might be revealed about how far the FOMC will go.

Consumer spending figures are also scheduled for release this week. Retail sales excluding cars and petroleum have been robust throughout the fall and I believe this trend will continue in the December's data, with growth of 0.45% m/m compared to 0.48% m/m in November. I don't expect the data will move the market much though since it doesn't directly deal with interest rates or inflation.

In contrast to the Federal Reserve, which until now was on tightening autopilot, the European Central Bank (ECB) emphasized that its December rate hike does not mark the beginning of a pre-programmed tightening cycle. They're taking more of a ‘hike-as-you-go” approach. 

This means that, like the current Fed, the ECB will be data-dependent. The ECB promises to monitor all risks and make the appropriate decisions based on incoming information.

Since this week's calendar is empty of any important key indicators for the Euroland, the focus will be on Thursday's meeting in the ECB Governing Council's The ECB is not expected to raise rates this meeting. The kabillion dollar question though is whether the ECB will speak a more hawkish tone to prepare the markets for an upcoming rate hike.

I do expect Trichet will provide a slightly more hawkish tone. He'll probably just reuse the text (hike-as-we-go) from the last meeting, but add a slightly more optimistic tone in respect to signs of some economic growth, while toning down new developments of inflation risks.

The bottom line is the market's focus right now is global interest rate differentials. So if Fed rate increases are coming to an end while ECB rate increases are still possible, then it's mostly like that the EUR/USD will rise. The catch is that the possibility of further rate hikes rests on forthcoming economic data. So keep your eyes open and ears peeled because the next couple of weeks and even months could be a volatile one.

EUR/USD

Weekly Chart

The pair managed to break and close outside its descending channel. It's hard to tell where it will go at this point though. Last week's move could be a fakeout, and the pair could fall back inside the channel. But if this is a real channel breakout, then I'd expect the pair to hit its 50 EMA. If the pair is able to close above the 50 EMA, look for it to rise to its 100 SMA. And if it closes above its 100 SMA, look for it to rise up to its most recent high – the horizontal grey line.

I've drawn Fibonacci retracement levels from the pair's high of 1.3666 to the pair's low of 1.1642. Notice how the pair was able to close above the 23.6 Fib level. If the Fed provides a stronger signal that they're going to stop raising rates, look for the pair to climb to the 38.2% Fib level. It could even rise to the 50% Fib level if ECB raises rates and the Fed stops raising rates. Keep in mind that the 50 EMA, 100 SMA, and grey horizontal line are still resistance levels so look for price to consolidate around these areas before resuming their upward move.

Also note that the blue 100 SMA and 38.2% Fib level are close together which makes it a very strong resistance area.

Daily Chart

Identify the Current Trend

The daily chart is what I use the current trend of the pair. The way I figure what the direction the trend is very simple. I use exponential moving averages (EMA) for my primary trend identification. I use 89 period EMA of the highs and 89 period EMA of the lows. This is my short-term trend.My long-term trend are 144 period EMA of the highs and a 144 period EMA of the lows.I use big long moving averages instead of shorter time periods because there's less whipsaw.I've found these periods to work well and they're also Fibonacci numbers.Uptrend
When both of the shorter 89 EMAs cross above both longer 144 EMAs, then the trend is up.Downtrend
When both of the shorter 89 EMAs cross below both longer 144 EMAs, then the trend is down.

On the chart above, notice how the trend is down (both 89 EMAs below both 144 EMAs). The trend is still down as long until both 89 EMAs cross above both 144 EMAs. Okay now that we've identified the current trend which is down, let's take a look at another daily chart.

The pair has broken out of its descending channel. Is that a new ascending channel forming? We'll have to wait and see. I think it's a little bit early to call it one. I want to see a few more candles form. If the pair can close above its most recent high, I see it at least hitting its purple 200 SMA. The pair nearing the 200 SMA is a big deal. Many traders will be keeping an eye on this moving average to see if the pair is able to close above it or simply bump its head and fall back down.If the pair decides to fall, the blue 100 SMA and the top Fibinnel is short-term support.If this new ascending channel ends up being real, and the pair manages to close below its pink 50 EMA and bottom Fibinnel, look for it to fall to the bottom of the channel.

Here's another view of the daily chart using Fibonacci retracement levels. The pair closed above the 50% Fib level, so look for it to rise to the 61.8% Fib level. Notice how the 61.8% Fib level and the purple 200 SMA are located around the same price level. This is an important resistance area. A significant resistance area. Watch it like a hawk. If the pair can break and close above this area, this could be the beginning of a possible trend change. This could trigger euro bulls to break out their wallets to buy and the rest of the dollar bears to come out of hibernation. Remember from the chart earlier how both 89 EMAs are still below the 144 EMAs? The 89 EMAs might start turning upward and potentially cross above the 144 EMAs if the pair can break above the area where the 61.8% Fib level and 200 SMA are located

4 Hour Chart

This chart is just plain ugly. I've drawn horizontal lines to denote the sideways range the pair has been trading in. Notice how the pair was able to break out of its first sideways channel, then briefly consolidate into another sideways channel. Now it appears to have broken out of its second sideways channel. I'm not entirely convinced of this breakout though because the next several candles (highlighted in purple) failed to close or even reach the high of the candle that broke out of the channel. A positive sign though is we can see the pair tried to fall back into its sideways channel but it looks like the 1.2140 level is acting as support. The best thing to do here is to be patient and wait and see what the pair will do next. If you want to be aggressive, you can go long on its support level at 1.2140, place your stop below its most recent low of 1.2124 and target the blue horizontal line at 1.2215. Why the blue line? Usually, if the price breaks out of a channel, its breakout move will equal the width of that channel. In this case, the width of the channel is about 75 pips. So I simply added 75 pips to its recent support level of 1.2140 which would give us a target of 1.2215. While I still think this trade is aggressive, the reward-to-risk ratio isn't too shabby. If you place your stop loss at 1.2120, you'd be risking 20 pips to grab 75 pips. This would give us a reward-to-risk ratio of 3.75. Once you have a profit of 20 pips though, I'd recommend you move your stop to breakeven. You might also want to take consider taking profit if the pair hits 1.2200. Big fat round numbers such as 1.2200 or 1.2100 or 1.2300 usually act as good support/resistance levels so cashing out at 1.2200 wouldn't be a bad idea. Your reward-to-risk ratio would still be 3 to 1.

1 Hour Chart

Here's another chart showing the pair breaking out its sideways trading range. Notice that when it did break out, the pair did rise to at least the same width of the channel it broke out of.I see two possible trade ideas here:

1. A long trade. Buy the pair hits support again at 1.2125. Your stop loss would be below the pink 50 EMA. Your profit target would be the blue horizontal blue line.
2. A short trade. If the pair closes below the 50 EMA, short the pair and target the black support line of 1.2075. Your stop loss would be above the black horizontal resistance line of 1.2125.

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