Weekly Technical US Dollar Forecast: Sell-Off May Be Finished

(MENAFN- DailyFX) Advertisement Technical Forecast for the US Dollar: Neutral

• The US Dollar (via the DXY Index) was on its way to its worst weekly performance since May 2021 before a late-week rally offered relief.
• US Dollar net-long positioning fell for the first time in a month, but remains near its most net-long level since October 2019.
• The IG Client Sentiment Index suggests that the US Dollar has mostly mixed bias against its three major counterparts.

The US Dollar's second week of 2022 was rather dismal. The greenback lost ground against all of its major counterparts, with the broader DXY Index falling by -0.60% on the week. USD/JPY rates produced the biggest move, falling by -1.16%. The first and third largest components of the DXY Index, EUR/USD and GBP/USD rates, gained +0.48% and +0.63%, respectively. But there was a notable shift in price action by Friday, and a sharp US Dollar rebound accumulated enough technical evidence to suggest that the worst may be over. It very well may be the case that the monthly lows for the US Dollar are now in the rearview mirror.

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The DXY Index dropped to its lowest level since early-November 2021, and along the way, it appeared that significant technical damage had been levied. The sell-off by the DXY Index saw price action break through the uptrend from the June, September, and October 2021 swing lows, but support was ultimately found at a familiar area around 94.65/74, where the March 2020 low, September 2020 high, and September to early-November 2021 highs were carved out. The rebound from this critical support region saw the DXY Index retake the June, September, and October 2021 uptrend, suggesting a false bearish breakout transpired. Gains above 96.00 are eyed over the coming days as a confirmation signal that the greenback sell-off has finished.

EUR /USD rates broke out higher from their two month-long triangle early last week, but did not advance meaningfully before resistance was met in a number of forms: the descending trendline from the May and September 2021 swing highs; the 50% Fibonacci retracement of the 2017 low/2018 high range; and the 50% Fibonacci retracement of the 2020 low/2021 high range. But perhaps most notably, the daily candlestick on Friday has taken the shape of a bearish outside engulfing bar, and coming in after a breakout, means it's also a bearish key reversal. A move back below 1.1380 would offer a strong confirmation signal that EUR/USD's bullish breakout as failed.

EUR/USD: Retail trader data shows 52.36% of traders are net-long with the ratio of traders long to short at 1.10 to 1. The number of traders net-long is 1.70% lower than yesterday and 6.35% lower from last week, while the number of traders net-short is 13.85% lower than yesterday and 4.95% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EUR/USD prices may continue to fall.

Positioning is more net-long than yesterday but less net-long from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.

GBP /USD rates have rallied more over the past three weeks than other USD-pairs, a testament to Sterling strength afforded by rising Bank of England rate hike expectations. Nevertheless, the two daily candlesticks to close out the week – a shooting star on Thursday followed by a bearish piercing candle on Friday – hint that a near-term top has been reached. But with the pair firmly above its daily 5-, 8-, 13-, and 21-EMA envelope, as well as daily MACD still trending higher above its signal line and daily Slow Stochastics holding in overbought territory, GBP/USD rates offer the least appealing setup to take advantage of a potential US Dollar rebound in the days ahead. On the other hand, if US Dollar weakness resumes, look to GBP/USD rates as a leader to the upside.

GBP/USD: Retail trader data shows 38.82% of traders are net-long with the ratio of traders short to long at 1.58 to 1. The number of traders net-long is 6.20% lower than yesterday and 16.73% lower from last week, while the number of traders net-short is 9.17% lower than yesterday and 20.31% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests GBP/USD prices may continue to rise.

Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed GBP/USD trading bias.

Weakness in US equity markets coupled with a dip in long-end US Treasury yields provided a near-perfect environment for USD/JPY rates to pullback last week – and that they did. In doing so, the uptrend from the September and December 2021 swing lows was broken, suggesting that the multi-month rally has finished. However, with the daily candlestick on Friday forming into a hammer, price action may be hinting that a period of choppy, sideways movement is ahead for the pair. USD/JPY rates may not be an appealing long yet, but there is early evidence that the worst of the selling may be finished in the near-term.

USD/JPY: Retail trader data shows 43.10% of traders are net-long with the ratio of traders short to long at 1.32 to 1. The number of traders net-long is 8.45% higher than yesterday and 25.89% higher from last week, while the number of traders net-short is 17.43% lower than yesterday and 34.70% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests USD/JPY prices may continue to rise.

Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current USD/JPY price trend may soon reverse lower despite the fact traders remain net-short.

Finally, looking at positioning, according to the CFTC's COT for the week ended January 11, speculators decreased their net-long US Dollar positions to 37,860 contracts from 39,057 contracts. Despite the decline, net-long US Dollar positioning remains near its highest level since October 2019, when the DXY Index was trading above 98.00. Further evidence of net-longs being liquidated could ultimately prove fruitful for the US Dollar on a longer-term basis as overcrowding has hindered additional strength.

--- Written by Christopher Vecchio, CFA, Senior Strategist

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