Is The Dollar Headed Into The Abyss?

Back in January, I attempted to answer the question “Is Dollar's Dominance Over?”, as the dollar index (DX) had experienced significant losses.

However, we received two conflicting signals from the technical chart, which provided a bearish alert, and the interest rate differentials chart, which indicated support for the dollar.

In both polls, the majority of readers voted that the dollar's dominance was over and that it had already peaked for the dollar index.

Since then, the DX has made a bounce close to $106 with the support of a hawkish Fed, however these gains proved to be unsustainable, and the price dropped back down to hit the valley established in January, reaching a new low of $100.

Is the dollar headed right into the abyss?

Let's take a look at some updated charts, starting with the interest rate differentials.

Source: TradingView

This time, I will be using a monthly time frame to provide a closer look at what could potentially cause the dollar to decline.

The majority of real interest rate differentials remain bullish for the dollar, with the orange line representing the gap between the US and UK establishing a new top of 6.15%, and the red line representing the US-Japan gap breaking into positive territory at 3.4% and catching up with the US-EU differential.

However, the US-EU differential represented by the blue line is spoiling the positive outlook for the dollar as it has been falling since its peak of 5% in September 2022. It's important to note that the euro is the largest component of the dollar index, and this downtrend in the interest rate differential is putting downward pressure on the DX.

The pace of the dollar's descent may be somewhat exaggerated, as it appears to be based more on an emotional outlook than on current fundamentals as the curve of the blue line is not that steep and the Fed is not yet running out of ammo.

The next chart follows to show the technical outlook.

Source: TradingView

The dollar index futures have now hit a crucial support level, with the orange dashed line on the chart indicating the 2015 high of $101 positioned just above the psychologically significant level of $100.

Additionally, the RSI indicator has reached the critical support level of 50. Indeed, the dollar is on the edge now.

At this crossroads, the dollar faces three potential paths.

The first path, illustrated by the blue arrow, represents a non-stop rise of the dollar towards the upside of the black uptrend line at around $117. This path could be supported by a more aggressive tightening from the Fed, a "flight to safety" scenario similar to the Great Recession of 2008, or a major geopolitical event.

The green path suggests that the upward movement seen in 2021-2022 was only the initial part, and we may witness a second upward movement after a period of consolidation around the current equilibrium. This view is more technical in nature, as it follows the concept that the 2001 peak at $121 should be retested before any major reversal occurs for the DX on a global scale.

The red path indicates that the dollar index futures may continue to weaken due to the growing trend of countries looking to trade without the use of the US dollar. This is reflected in the increasing number of countries expressing their desire to move away from the dollar as the world's reserve currency.

The initial support level would be at the downside of the uptrend around $94, while the growth point of $89 in the valley of 2021 would be the subsequent crucial support.

Intelligent trades!

Aibek Burabayev
INO.com Contributor

Disclosure: This contributor has no positions in any stocks mentioned in this article. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.