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Weekly FX Review - 13 September

Macro overview

The dollar strength pushed the pound down to fresh lows last week, at its lowest reaching levels not seen since 1984. A move this significant has even allowed some more bearish long-term analysts to flag up a possible long-term shift back to parity on the pound.

The US dollar strength also pushed the euro further under parity, down under 0.985 at one stage, which is a twenty-year low for that major pair. The energy crisis continues to weigh especially heavy on European currencies with ongoing talk of possible power rationing this winter. Although in the past few days the euro has managed to push back above parity to trade at 1.016. Is this just a minor recovery within a longer-term negative trend, or the start of a more meaningful leg higher?

The trend for 2022 has been clear: dominance of the US dollar. But will this longer-term trend re-assert control, or can the buying interest in the euro continue to post a more meaningful recovery?

The technical analysis tenet is “the trend is your friend”, which indicates a negative longer-term skew on the euro if these trends persist.

Technical picture

1D US dollar index (Source: TradingView)
Historical performance does not guarantee future profits.

The dollar index is a measure of the value of the US dollar against a geometrically weighted basket of six other major currencies: euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc. It can be used to provide guidance on the strength of relative US economic performance, especially in regard to exports, as the higher the exports the greater the demand for dollars required to buy the goods.

The dollar index had pushed on to fresh 20-year highs in recent weeks, highlighting how the dollar continues to be supported by the expectation of continued sharp rate hikes by the Fed. This creates a strong expected interest rate differential to the other leading currencies and creates conditions for a powerful medium-term trend.

Has it made enough of a move already?

Back in May, the index posted an RSI Failure swing, where price action posted an increased high. But the RSI failed to post a comparable higher high while being overbought (black lines on chart), setting up divergence. This suggested that the momentum had turned, and price action dropped to the lower end of the positive trend.

The price recently was once again in overbought territory. With no clear divergence in the RSI, the price still came off from these highs and seems to be dropping back to the lower end of this trend once again.

The slight slide in the US dollar in recent days could continue over the next week and it could drop to the lower end of its trading range. This may give some respite to the other currencies in the short term. But questions will remain on how far this can continue for the longer-term. Can the euro stay above parity in this environment? It would need to break the strong bearish trend that has been in place from late 2021 to do so.

Outlook

So, can the pound continue its recovery from 40-year lows, or have the recent gains just been a relief rally?

The longer-term trend on the dollar index appears very strong. Moves well under 104.00 would be needed to indicate the tide was turning. This keeps a negative skew on the pound and euro as the recent gains could turn out to be yet more bear rallies that eventually fade.

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