Next Global Crisis – Strengthening U.S. Dollar Index or Weakening Euro?

The U.S. Dollar was the source of much volatility last week as traders were forced to endure a number of factors affecting its value. These included U.S. government reports, U.S.-China trade relations and weakening economic data from China and the Euro Zone. At times, the price action was affected by investor appetite for risky assets and whether the Fed will continue to pause future rate hikes.

Last week, the March U.S. Dollar Index settled at 96.740, up 0.324 or +0.34%.

Battle Between Dollar Bulls and Euro Bears

The price action last week suggests investors are being a little tentative about buying strength. In three sessions out of five, the dollar index rallied to highs not touched since early December before closing lower. On Friday, the dollar index reached its highest level since April 21, 2017 before posting a dramatic technical closing price reversal top.

This type of price action strongly suggests there is a battle going on between strong buyers responding to the dollar’s safe-haven appeal and the strength of the U.S. economy relative to the other major economies, and strong sellers who are trying to prevent a surge to the upside which could wreak havoc with the global economy, especially in the emerging markets.

Friday’s price action also suggests that the U.S. Dollar may have hit a critical area on the charts. One that have ramifications across the board in the global equity and gold markets. If sellers can take control then the dollar index should feel enough pressure to support higher stock and gold prices. However, if the dollar index continues to rally then equity and gold traders will have to face the possibility of dramatic sell-offs.

Euro Major Influence on Dollar Index

When talking about the U.S. Dollar, it is important that one distinguish between the greenback’s relationship against a single-currency and against a basket of currencies. And there is a major difference because of the way the dollar index is constructed, particularly the weightings of the individual currencies in the index.

The U.S. Dollar Index is often called a measurement of the dollar’s value against a basket of major currencies. However, it probably doesn’t represent what you may think. The index is actually a weighted geometric mean of the dollar’s value relative to the following select currencies:

Euro = 57.6% weight

Japanese Yen = 13.6% weight

British Pound = 11.9% weight

Canadian Dollar = 9.1% weight

Swedish Krona = 4.2% weight

Swiss Franc = 3.6% weight

As you can see, the price action in the U.S. Dollar Index futures contract is essentially controlled by the movement in the Euro.

Euro at Critical Support or Dollar Index at Critical Resistance?

Last week, the EUR/USD hit a low of 1.1234. This was just slightly above the November 12 bottom at 1.1216. The dramatic reversal from this low wasn’t enough to produce a potentially bullish closing price reversal bottom, but it contributed to a potentially bearish closing price reversal top in the U.S. Dollar Index.

With the Euro exerting the biggest influence on the dollar Index, its movement this week will dictate whether the Dollar Index retreats from its high, or continues to break out to the upside.

Best Bet on Dollar Index Continuing Its Climb

Judging from the way the dollar index is weighted, the best bet for another surge to the upside will be a weaker Euro, Japanese Yen and British Pound. The catalysts behind another spike in the March U.S. Dollar Index will be a weaker Euro Zone economy, which should drive the Euro lower, a weaker Japanese Yen, which could be fueled by rising U.S. Treasury yields which will help widen the spread between U.S. Government bonds and Japanese Government bonds, and a weaker British Pound, which could weaken if the Brexit process goes the wrong way.