Double-topping Dollar?

06/18/02 08:10:41 AM

by David Penn

Is current greenback bullishness just another countertrend rally in a declining trend? Watch the yen.

Security: AUD/EUR/GLDUSD, USDJPY
Position: N/A

Dollar bulls have had a hard spring. As I've noted elsewhere ("Channels Inside Channels" June 6, 2002, Traders.com Advantage), the collapse of the dollar this year has been a textbook case of bearish breakdowns leading into bearish consolidations leadings, as they tend to do, into further declines. A breakdown from a descending triangle in April took the U.S. Dollar Index ($DXY) from 117 to 114. And a breakdown from a bearish flag in May took the $DXY from a countertrend peak of 115 to its most recent lows of 111.

The declining dollar has been pronounced in the Forex markets, where the Australian dollar, Euro, Canadian dollar, and Japanese yen have all made significant gains. In the mainstream business press, the clarion call for investing in overseas mutual funds rang out. "The Case for Going Global" cheered Mutual Funds magazine in July of this year: "U.S. stocks have reigned for well over a decade. Don't bet on more of the same." And while I take nothing away from the argument that a secular shift away from U.S. assets is in fact taking place, there is much in the way of details (what to buy? when to buy? and, of course, when to sell that as well?) that need to be resolved.

Still, the degree of the dollar's decline is such that I'm hard pressed to call for a rally in the near-term. But many dollar bulls have begun to believe that the dollar's springtime of declines may give way to, if not a summer rally, then perhaps at least a little summertime relief. This thinking is supported in part by the recent collapse of the AUDUSD (Australian dollar/U.S. dollar) pair that, after peaking above 0.5740 in early June, fell as low as 0.5520 by mid-month, as well as the toppish appearance of both the EURUSD (Euro/U.S. dollar) and GLDUSD (Gold/U.S. dollar).

Figure 1: After a spectacular run against the greenback, the Australian dollar suffers a sharp correction.

Graphic provided by: ACTForex.com.

Figure 2: The Euro broke out of an ascending triangle in late April, but its rally looks to be running out of steam in June.

Figure 3: The yellow metal has been the surprise investment hit of 2002. But a correction in June has taken some of the punch out of the gold party.

All of these interpretations of the USD seem to suggest strength for the greenback--if only in the near-term. How does the USD stack up against the Japanese yen, however? An eight-month daily chart of the USDJPY (U.S. dollar/Japanese yen) shows a dollar that rallied powerfully against the yen from November 2001 until the head and shoulders top formation that developed early in 2002. A sharp correction in March led to an equally sharp rally, though the rally in the second half of the month did not take out the previous high in the USDJPY established in February.

Figure 4: Will a double top in USDJPY mean more trouble for the greenback?

The correction from this failed test of top sent the USDJPY reeling from 133.70 to 126.70. The fall through the 126.70 level completed the double top formation in the USDJPY, a formation that seems to be confirmed by the way USDJPY has traded since falling below 126.70.

Figure 5: May-June head and shoulders bottom? A mere countertrend rally? The steepness of the downtrend suggests caution for USDJPY bulls looking to pick this bottom.

The most recent lower low--following the breakdown beneath 126.70--came right at the end of May. Since that time, USDJPY indeed has been moving up, gaining 300 pips from the May lows to the June highs. But already USDJPY is backing off the June highs, suggesting that resistance in the 126.80 to 125.80 area. Presently, the bullish case for USDJPY would require a successful retest of the June highs and an avoidance of the May lows. As it is, the June rally looks increasingly like a pullback to the "neckline" where USDJPY's double top appears to have broken through. If the latter is the case, then USDJPY dealers should strongly consider the likelihood that the double top will assert itself again, sending USDJPY toward a target minimum of 118.7, which would take out the lows of November 2001 and match the August 2001 lows. At that point, the lows of September 2001 would only be another 300 pips away.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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DOUBLE TOPS

Double-topping Dollar?

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