U.S Dollar Index (DXY)
The U.S Dollar Index (DXY) is a measure of U.S. Dollar strength against a basket of other major currencies. It was developed by the U.S. Federal Reserve 1973 after the dismantling of the Bretton Woods system and is now the global benchmark for fiat currencies. When the United States suspended the gold standard, the DXY became necessary for valuing the currencies of U.S. trading partners in relation to each other. World currencies were no longer pegged to USD and their relationship to it began floating freely. The only change to the DXY since its inception has been the addition of the EURO in 1999 when it replaced a group of European currencies.
The DXY index is made up of the following:
Euro (EUR) 57.6% weight
Japanese yen (JPY) 13.6%
Pound sterling (GBP) 11.9%
Canadian dollar (CAD) 9.1%
Swedish krona (SEK) 4.2%
Swiss franc (CHF) 3.6%
The USD has become the reserve currency of most countries in the world and because of this their central banks hold USD as a hedge against inflation. This is mostly due to the long term stability of the U.S. Dollar and the U.S. economy. Today, more than 61% of all foreign bank reserves are denominated in U.S. dollars, and nearly 40% of the world's debt is in dollars as well.
Current DXY Outlook
The DXY has been in a strong downtrend since topping on March 23rd 2020, falling about 12% to where it sits today at 91.04. This downtrend has been influenced by the global pandemic and the exponentially increasing creation of US Dollars as a result of government spending and stimulus. M2 money supply has increased by 25% since the start of the pandemic, and more dollars in circulation has put downward pressure on the dollar. Other currencies such as the EURO and Canadian Dollar have also been in strong uptrends, further contributing to USD weakness.
Over the last year, sentiment surrounding the U.S. Dollar has been largely negative. Many professionals have been short the dollar throughout the year and their outlook continues to be bearish. That said, over the last six weeks price has come down into a significant level that should interest us as technical analysts. If the dollar is due for a bounce or pivot we should look for it in this area. Currently the DXY is trying to form a bottom off of the .886 Fibonacci retracement level drawn from the 2018 Bottom to 2020 top of the last rally.
A classic Inverse Head & Shoulders Pattern has confirmed a breakout on the daily chart and it has most recently pulled back to the neckline. If this head and shoulders is in play we should expect a bounce off this neckline area before continuing higher. Drawing a 200% extension of the head and shoulders projects an upside target of 92.82.
While U.S. Dollar sentiment is largely bearish and many in the media are calling for a continuing down move, we are seeing technical signs of a reversal and beginning of an upward trend this year. If the DXY can hold its current bullish head and shoulders pattern then we can be looking for a move up into the $91 area, however if it loses its lows around the 89.20 level then the pattern is invalidated and we can expect a further move to the downside.
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