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John Forman is a Forex author and expert. He is the Senior Foreign Exchange Analyst for the IFR Markets group of Thomson Reuters and frequent blog poster on Currensee.com.

The Case for the USD Having Made its Bottom

by John Forman

1-20-10

For the last year or more the dollar has garnered a considerable amount of the attention of the global markets. For much of 2009 it was about the inverse relationship between the USD and stocks. The strong rally in the greenback during the month of December, however, changed things quite a bit in terms of the inter-market relationships. There is also very good reason to believe it also told us the dollar’s bottom has been put in, at least for some time to come.

First, let’s consider the daily Dollar Index chart and what’s developed there.

Daily Dollar Index Chart

The most obvious reason to suspect the market has at least stopped falling is the fact that the pattern of lower highs and lows has clearly been broken. Now add to that the relatively shallow retracement which took place from the December peak to the lows earlier in January. It wasn’t even 50%. Shallow retracements are indications of strong markets, not weak ones.

Especially interesting on the chart above is the narrowness of the Bollinger Bands, as indicated by the bottom Band Width Indicator (BWI) plot. It’s telling us the Bands are now about as narrow as they get, and if you look at the chart you’ll see that narrow Bands quite often precede meaningful directional moves in the market. If the Dollar Index holds a break through the December high it will be well positioned to move nicely higher. On top of that, the relatively low Normalize Average True Range (N-ATR) reading says there’s room for a volatility expansion.

The weekly chart suggests an even bigger picture bottom having been put in.

Weekly Dollar Index Chart

Notice how the December lows were well above those registered back in 2008. If there is a break higher we would have to call that December bottom a higher low following on the heels of some very notable highs. This would, at a minimum, strongly argue for the dollar to be working through a wide consolidation.

Again, though, notice the narrowness of the Bollinger Bands. They could potentially get more narrow, but they are sufficiently tight for us to start looking for the next big move to unfold. A sustained move through the December peak would likely initiate something along those lines.

The monthly chart actually argues pretty well for a wide consolidation being worked through at this point.

Monthly Dollar Index Chart

Notice here that we are looking at wide Bollinger Bands narrowing rather than the narrow Bands potentially set to start widening in the shorter timeframes. Also notice how N-ATR is dropping from its highest reading in the last 10 years. At the same time the chart shows the latest highs slightly lower than the prior major ones and prospectively the most recent lows being well above the ones from 2008. So we have volatility declining at the same time a triangle type of pattern may be developing. That argues consolidation, not trend.

The implication of all this is quite bullish in the near term, especially if those December highs are broken clearly and held. The dollar would have a lot of room for gains, even within the scope of a monthly timeframe consolidation. A 10% rise is not at all out of the question. That kind of rise would probably put EUR/USD in the 1.2700 area.

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