marctomarket.com / by Marc Chandler / October 21, 2017
The prospect of tax reform and a Fed hike in December, with expectations of more next year,helped lift the dollar broadly last week. Although the Japanese election and ECB meeting lie ahead, the fundamental backdrop for dollar looks constructive. The technical condition is also favorable, especially on the weekly charts.
The Dollar Index continues to appear to be carving out a bottom after trending lower through early September. There are two key levels to monitor. On the downside, it the Dollar Index falls through the 92.55-92.75 area, the favorable chart pattern will be challenged. On the upside, the move above 94.25 would suggest a more significant recovery is in work, signaling potential toward 96.50-97.00.
Technically, the euro may be forming a large topping pattern. A break of the mid-August and early October lows near $1.1660 is needed to confirm the pattern, and a break of $1.1600 would likely signal a move toward $1.1250 in the coming weeks. The weekly MACD and Slow Stochastics favor the eventual downside break. On the other hand, a move above the $1.1880-$1.1910 area would undermine the credibility of the pattern.
The 10-year interest rate differential between the US and German widened from the year’s low near 1.70% to 1.95% in recent days, the most in four months. The US two-year premium has continued to rise, reaching almost 2.30% before the weekend. It is the most since 1999. There is not a one-to-one correspondence between the level of the euro and the rate differential. However, we find that direction is more important. The correlation of the percent change in the euro and the two-year interest rate differential is still about 0.4 over the past 60 sessions, which is still robust from a historical perspective, even if off the peak near 0.6. The correlation at the longer-end is also near 0.4, which is robust for this time series.