Potential Head and Shoulders Bottom in the Dollar Index

dxyThis chart was composed on Bloomberg.  It shows the recent price action of the Dollar Index.  There seems to be a head and shoulders bottoming pattern that has been traced out over the last few weeks.  The right shoulder was carved last week, and today, the Dollar Index is pushing through the neckline, which is found by connecting the bounces after the shoulders were formed.  

One of the important contributions of technical chart patterns is that they offer measuring objectives.  The measuring objective of a head and shoulder pattern is the distance from the head to the neckline.  In this case,the head is near 91.00 and that the neckline is found near 92.60 today.  The 160 point pattern projects toward 94.20.  That corresponds to the mid-August highs, and the lesser used 23.6% retracement of the down move since the start of the year.

Other technical indicators also suggest a move constructive outlook.  The 5-day moving average is moving above the 20-day average for the first time in a month.  The RSI and MACDs have been trending higher since early August, despite prices making a new low in early September.   The 50-day moving average is found a little below 93.00.  The Dollar Index has not traded above it since mid-April.

The two-year interest rate differential, which over time, does a fairly good job of tracking the euro, has been trading higher since late June when it last dipped below 1.95%.  Today it is trading near 2.13%, the highest since March.  The 10-year differentials is near 1.82%,which is the upper end of the Q3 range.  It reached almost 1.70% in mid-July.

Although Merkel will be Chancellor for a fourth term, the coalition composition will change, and on the margins, this will make many less optimistic on the resuscitation of the Paris-Berlin axis that was once regarded as the two pillars of Europe.   At the same time, the market feels more confident of a December rate hike by the Federal Reserve, while the ECB’s tapering is expected to be extremely gradual.  Its balance sheet is expected to expanded well into next year, while the Fed’s begins to slowly decline starting next month.