In our July 22 update on currencies [see: Currencies, a Turning Point] we noted that DXY was in danger of breaking down even though EURUSD was approaching strong overhead resistance. Since then, DXY’s rising purple channel dating back to 2010 did, in fact, break down… …at the same time that EURUSD reached our upside target at 1.19.

With DXY now in Fibonacci no man’s land and EURUSD at overhead resistance – a channel dating back to 2006 – we’re looking at an important inflection point for the US dollar.

continued for members…

As SPX continues its meltup toward its February all-time highs… …we’re left with a significant divergence between interest rates and stocks.

As we’ve discussed lately, TNX/ZN seem to be on a very well-defined track to specific targets.The 2s10s spread has also become a non-factor – with the breakdown so gentle as to be almost unnoticeable.

The interesting thing about the TNX, ZN and 2s10s charts is that they all point to a denouement in November – presumably after the election.

DXY’s white midline target – at either the purple .382 at 91.167 or, alternatively, the white .382 at 89.921 – would ideally fall around election day.

A breakdown through the midline would imply a breakout in EURUSD. As mentioned above, EURUSD has already reached important overhead resistance – the falling red channel dating back to 2006.If it were to break out, the potential upside is considerable. The yellow neckline was backtested back in January 2018 (at the same time as the red channel top and yellow .618), but that doesn’t mean it couldn’t be backtested again. It’s currently around 1.2597 (the level of the yellow .618.) If EURUSD were to push through it, we’d start looking at the upper yellow and red Fibs such as the yellow .786 and .886, followed by the red .618. The reality, though, is that the elimination of the falling red channel from guidance would mean the rising white channel is in charge – implying a price target which intersected with one of the white channel lines.

The first is the .236 line currently around 1.22. There are no Fibs to intersect with there. In fact, that channel line doesn’t reach any important Fib levels until late 2021. However, if we look at the drop from Feb 2018 to May 2020, we can see an intersection with the white .886 at 1.2336 in Feb 2021 (note that I’ve grayed out the former white Fib grid.)

While potential upside targets are easy to spot, it’s unclear whether we’ll get a breakout in EURUSD. At present, the fundamentals suggest it is quite likely. The US, which has avoided ultra-low and/or negative rates in the past, is quickly “catching down” with the eurozone and Japan due to the economic and geopolitical fallout from its horrid response to the pandemic.

I’ve heard nothing from the Fed that would indicate they’ll pull back from their massive monetary response. And, with an election looming, we can hardly expect politicians to suddenly take a tougher stance toward deficit spending and spiraling debt. It’s much easier to imagine both parties attempting to outspend one another to gain favor with voters.

On the other hand, the Fed and ECB have kept the EURUSD in that falling red channel for a reason. It has served both regions well, through periods of both high and low inflation, economic strength and weakness, and massive political shifts.

The EURUSD and SPX were highly positively correlated during 2008-2009, Dec 2016-Jan 2018, and since the Mar 2020 lows. Between Jan 2018 and Sep 2019, however, they were generally either negatively correlated or in a special relationship which saw EURUSD’s lower lows align with SPX’s higher lows.

The period that interests me the most is June 2017. EURUSD had just broken out of a falling channel and horizontal resistance. SPX was only to happy to tag along. Note that CL also experienced a significant low that month which saw CPI dip significantly from recent levels.

With (a) inflation currently being so low, (b) the Fed having no reason to boost interest rates, and (3) US interest rates closing in on ECB and BoJ levels, I can see no reason for a rise in rates any time soon. So, it’s a reasonable assumption that the USD will be under increased pressure. The question is whether and how long it will bounce (EURUSD fall) first.

Remember, DXY can fall based on yen or euro strength. With USDJPY likely to drop through its July 31 lows and potentially test its March 9 lows, I’d be bearish enough on DXY. But, if EURUSD breaks out of a 14-year channel, I’d be very, very bearish.

I like the idea of DXY making an extended backtest of the broken purple channel, maybe as high as 94.662 in last September, followed by a rapid unwind to 91.358 around the election. But, with both Congress and the White House competing to see who can shower the most money on voters and the Fed printing money hand over fist, the bounce could be over quite quickly and the ensuing drop even greater.

Stay tuned.