THE DOLLAR RALLY MAY HAVE A LONG WAY TO RUN / BARRON' S MAGAZINE

GETTING TECHNICAL

The Dollar Rally May Have a Long Way to Run

The U.S. dollar index took out a major hurdle on its long-term chart, suggesting it can keep rising.

By MICHAEL KAHN

Whatever the fundamental issues driving the move – the economy, global trade, or a flight to safety – the technicals look bullish for the long term.

Many dollar forecasts start with the U.S. dollar index, which is a trade-weighted basket of currencies, each paired against the greenback. The euro still makes up more than half the weight of that basket but it is not the only currency against which the dollar is rising. 

A long-term chart of the index shows the convergence of two major resistance features in the 84.75 area (see Chart 1). After rising from roughly 80.00, in round numbers, in less than three months, the index paused just under that ceiling this month. And Wednesday, it finally punched through, trading above 85.00 for the first time since 2010.

Chart 1

U.S. Dollar Index

Trends in currencies, once they get going, tend to persist for a long time and are often measured in years. Clearly, there was no major trend for the dollar for the past two years as the chart shows choppy sideways movement. Even the cyclical bull and bear markets that took place in the aftermath of the financial crisis of 2008 lasted no more than nine to 12 months.

But looking back in time, we can see trends that lasted on the order of a decade. I am not suggesting the dollar is in the dawn of a 10-year run, but rather that this may be the start of a long period of dollar strength, and all the consequences that brings to economists and gold bugs. 

Of course, we should not confuse the long term with the short term. The dollar index is technically overbought, meaning that it has risen too far, too fast, to sustain its current pace. That does not mean it will immediately back down, but it is a dangerous condition for new dollar buyers. Even with the technical breakout in place, overbought markets can stall just enough for weak bulls to question their choices. The ensuing shake-out sets the stage for the next leg up. 

Whether the short term sees a pullback, a pause or neither, we can project a possible upside target for the index based on the pattern from which it emerged. The 2005-2014 pattern is a bit huge for me to comfortably use for target-setting, but the two-year range from 2012 is indeed reasonable. 

By taking the height of the pattern and projecting it up from the breakout point we get a target in the $90.20 area. That is near the 2008, post financial crisis high of $89.62 and gives us an idea where the market can go over the next year, assuming the current breakout holds.

One look at a euro chart confirms this to be a reasonable target, with or without a correction in the current trend (see Chart 2). Using the CurrencyShares Euro Trust (ticker: FXE ) as a proxy, the current multi-month slide is clear, as is support at major lows in the $119-area (the ETF traded at $126 Wednesday). 

Chart 2

Euro ETF

Long-term declining trends in the Canadian dollar and Australian dollar are also clear. The British pound may have declined in part due to last week's Scottish independence vote, but its long-term chart shows a breakout failure in place since August. That is bearish for the pound and bullish for the dollar.

The Japanese yen, representing just under 14% of the dollar index's weight, is in a long-term bear market already and exhibits a waterfall type of pattern on its chart. Since peaking in 2011, the CurrencyShares Yen Trust is down more than 30% and is the weakest major currency of all. 

Other currencies are not faring much better. The Brazilian real, for example, recently broke a multi-month range to the downside. The Mexican peso is flat at best over the past two years. And the Indian rupee is now flat after falling from a 2011 peak. 

The bottom line is that the U.S. dollar is finding strength vs. the world. Whether that means the domestic economy is more enticing or simply safer than the rest is for others to ponder. No matter the reason, on the charts we see indications that a new bull market may be underway.

Getting Technical Mailbag: Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.

Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis..