US Dollar Reaching Exhaustion Point?

The dollar has shown some extended price action over the last several weeks and many forex traders and ETF investors are wondering whether these moves can continue.

There is some degree of flexibility here in terms of where markets are likely headed into the final parts of the summer. But at this stage it is relatively clear that the Federal Reserve is ready to continue raising interest rates, and this is something that could bring the PowerShares DB US Dollar Index Bullish (UUP) up from its prior lows.

Forex traders looking to establish positions in instruments like the euro, the Japanese yen or the British pound will need to remain watchful of the Fed in its next round of policy commentaries. This will be the best way of assessing how concerned it is about the inflation picture and whether we will actually see two additional rate hikes at separate meetings before the end of this year.

Currently, there is still speculation both ways about whether the U.S. economy can withstand further rate increases this year. If not, we can expect lower valuations in assets that are tied to the value of the greenback. The downtrend in the PowerShares ETF has been orderly in ways that are sustainable. Activity in the iShares MSCI Emerging Markets ETF (EEM) will give us a better understanding of what is happening in Asian currencies, and we have already seen some interesting moves in the Chinese yuan renminbi and Malaysian currencies already this year.

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But the fact that we have now seen a five-wave bearish series suggests that the extent of the downtrend might have run its course. This type of analysis lies in conjunction with the Elliot Wave theory, but the underlying trends here have been largely validated by the economic data as well. We have seen strong performances in manufacturing productivity and national jobs data in the U.S. and this is something that could make it easier for the Fed to act in a hawkish fashion again before the end of this year.

Alternatively, forex investors can view the CurrencyShares Euro Trust ETF (FXE) in terms of the ways it suggests broader strength or weakness in the peripheral majors. Forex ETFs generally pose the chosen currency against a basket of currencies, so if we are seeing rallies in CurrencyShares while we are seeing declines in PowerShares, it would suggest the need for sell positions in forex pairs like euro/dollar. Continue to watch for bounces off support at 1.1280 as this was previously an area that acted as resistance and COT reporting data already suggest that we are seeing a cluster of stop loss activity developing in this area.