Tuesday, January 25, 2011

Don't Rush to Bury The U.S. Dollar

Euro US Dollars
Forex: Don't Rush to Bury The U.S. Dollar

Financial markets -- i.e., investors -- have a short memory. For example: At Elliott Wave International, we have pointed out time and again that when market sentiment reaches a bullish or bearish extreme, chances are that a trend change is near. Yet time and again, almost everyone forgets this.

Here's a fresh example. In June 2010, the U.S. dollar began a losing streak against its forex competitors, especially the euro. Market observers threw on the pile just about every "fundamental" reason to be bearish the buck: high U.S. deficits and unemployment, weak economy, and -- the granddaddy of them all -- the Federal Reserve's quantitative easing program. (Also known by the abbreviation QE2 and the misnomer "money printing.")

Our Currency Specialty Service editor Jim Martens captured the uber-bearish dollar spirit in the November 2010 issue of our monthly Global Market Perspective (published Nov. 5):

Dollar weakness is viewed as a sure thing by many, just as the technical evidence points to an impending bottom. ...sentiment shows a lopsided lack of bullishness toward the buck that, according to Trade-Futures.com, recently dipped into single digits. It comes as no surprise that this outlook lies in contrast to the available technical evidence.

The EURUSD chart shows it best. The euro recovery from June is in three waves. It has retraced approximately 61.8% of the almost year-long decline. Within the recovery, wave (C) is virtually equal to wave (A) and has reached the upper channel line. The structure, extent and internal relationships within the recovery are all characteristics of a correction and suggest the euro is near its peak.


The actual dollar low suggested by this Elliott wave analysis came on November 4 -- the very day QE2 was formally announced (oh, the irony). Wrote Jim Martens in his Currency Specialty Service:

Since May [2010], sentiment has turned 180 degrees. In May, just before the euro bottom, the focus was on the troubles in Greece and the coming issues Spain and Portugal. Listening to the press, the euro could go nowhere but lower. Six months later, the story is QE2, and the only outcome is a falling dollar. This only after the buck has already gone down substantially. This is a perfect example of how the news reaches an extreme and is widely accepted just as a turn that goes against the expected outcome occurs. This time, the bearish dollar news is actually bullish.

Indeed, the USD has only gotten stronger since November. Here's what the same EURUSD chart looked like in early January:


Why is it important to remind ourselves of the huge role collective psychology plays in the markets? Because the chorus of "concerns" about the dollar's well-being has started once again.

See, the EUR has gained against the USD recently, pushing the exchange rate from $1.29 to near $1.37. And to some (many?), this is again signals the start of "the death of the dollar."

Will history repeat itself? You don't need to wait to find out. Read our latest Elliott wave forecasts for the EURUSD and other currencies in the Currency Specialty Service online now.

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