The world’s reserve currency has lost some of its shine in recent months.

For example, lengthy delays on Trumps tax reform… uncertainty around health care… and (perceived) hawkish language from European central bank chief – Mario Draghi – have combined in sending the US dollar lower.

Shortly we will take a look at the all important weekly chart… and why the tape indicated lower prices were in store early May.

But first… what’s happening in Europe is having a major bearing on global currency markets (and precious metals).

The euro – above all other currencies – has the most weight against the dollar index. As such, if it catches a bid – then the US dollar will naturally move lower.

This is good news for risk currencies like the Aussie – and also gold.

Let me explain…

Draghi Sends US Dollar Lower

The greenback is now trading at 10-month lows against the euro.

This might sound strange given the Federal Reserve is the only central bank in the world on a rate tightening path.

That is until Draghi spoke…

After years of unprecedented monetary stimulus and negative interest rates to spur economic growth – Draghi hinted that the ECB might begin to reduce the central bank’s stimulus.

By way of background – in January of 2015 – the ECB announced an ‘expanded asset purchase programme’ — where a staggering €60 billion per month of euro-area bonds from central governments, agencies and European institutions would be bought (despite Germany arguing against it).

Beginning in March 2015, the stimulus was planned to last until September 2016 at the earliest with a total QE of at least €1.1 trillion.

But it was clear the Eurozone needed a lot more support than just €1.1 trillion…

Mario Draghi announced the programme would continue: ‘until we see a continued adjustment in the path of inflation’, referring to the ECB’s need to combat the growing threat of deflation across the eurozone in early 2015.

On 10 March 2016, ECB increased its monthly bond purchases to €80 billion from €60 billion and started to include corporate bonds under the asset purchasing programme and announced new ultra-cheap four-year loans to banks.

Note: this is the first time a central bank has moved in to start buying corporate debt with printed money. 

Put simply – Draghi was doing “whatever it took” to ensure the euro (and Eurozone) did not sink.

And that meant printing money indefinitely to buy more debt.

This week – at a conference in Portugal – Draghi said the ECB could adjust its policy tools of sub-zero interest rates and massive bond purchases as economic prospects improve in Europe.

This was enough for the euro to jump 1.5 percent — its biggest daily percentage gain against the dollar in more than a year.

To ensure the market didn’t get too skittish — he reassured investors that the bank’s stance should be gradual, as “considerable” monetary support is still needed and the rebound in inflation will also depend on favourable global financing conditions.

US Dollar Reaction

The move in currency markets was immediate… as I say the euro jumped sending the US dollar lower.

However, as I was saying in the preface, the (big) move lower for the US dollar was in place 7 weeks ago:

US Dollar Index: June 28 2017

A few things to highlight using the weekly timeframe:

(1) we signalled to traders to expect resistance in the 61.8% zone outside our distribution. That was a level of 104. Almost on cue – the dollar touched that level then reversed course;

(2) whilst we found some support at the 35-week EMA on the retrace – our weekly trend failed the week of the 19th of May. From there, probabilities told us we should expect downward pressure on the dollar

(3) The bottom of our distribution is 94.5. This is where I think we might see the dollar trade in the coming weeks / months (especially if the euro sees further upside).

However, the move to 94.5 won’t be in a straight line.

The rush to euro’s has been fast (and overdone) therefore we should expect a pullback (and bounce in the USD) soon enough.

Keep your eye on the weekly-MACD in the lower window.

When we see this turn – you will know there is some buying pressure coming back into the dollar. It’s not there yet (and why I think there is more downside in the near-term). However, when the buyers return, we will see this pivot.

Putting it All Together

One person wishing for dollar weakness will be Donald Trump.

Trump doesn’t want a stronger dollar.

A stronger currency makes US-made exports more expensive (and arguably less competitive). Further to that, a stronger dollar is also deflationary.

However, should the Fed Reserve continue with their hawkish stance (ie raising short term rates whilst (slowly) reducing their balance sheet by not renewing bonds as they mature) — this will underpin US dollar strength.

The other group of investors cheering for a reduction in Euro QE will be precious metals.

Gold’s biggest competitor is the US dollar. A strong US dollar means a weaker gold price and vice versa.

However, the US dollar’s largest trading partner is the euro.

As we explained, a stronger euro means a weaker dollar. Weaker dollar equals stronger gold.

Everything is related in this financial universe…  and it’s just a matter of connecting a few dots.

From mine, the US dollar remains the best horse in the glue factory.

They are the only central bank raising short-term rates and their economy appears to be travelling ok. It’s not great – but not bad either.

The eurozone has been showing signs of renewed growth however will be on the “QE drip” for sometime yet… as Draghi indicated.

And whilst that drip might be reduced slightly — they are a long way from (rate) normalisation.

… trade the tape

When investing in shares, you can lose you some or all of your money. The potential gains on my blog are based on investing in Australian and US markets and don’t include taxes, brokerage commissions, or other fees. It’s important you seek independent financial advice regarding your particular situation. For any investment, never invest more than you can afford to lose, and keep in mind the ultimate risk is that you can lose whatever you’ve invested. If in doubt – always seek independent financial advice.

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