Market analysis

Fundamental vs technical analysis: spotlight on DXY

By Paul Reid

07 February 2024

Week 6 DXY

When it comes to forecasting, some check the news first and others go straight to the charts. In this article, experts in fundamental analysis and technical analysis go head to head on the future of DXY.

Technical perspective - medium-term market overview

Li Xing Gan, CMT, CFTe - Financial Markets Strategist

Anticipated future movements

Have you ever taken a peek at the DXY chart and wondered about the key levels and potential movements? Let’s dive into the details of the DXY chart, highlighting key support and resistance zones and what they could mean for traders.

On the weekly timeframe, DXY is holding in a descending channel, having recently rebounded from the support zone at 102.00 (USD). This support zone coincides with the Fibonacci confluence levels, hinting at a potential upward swing. However, as prices edge closer to the resistance zone at 106.20, caution may be advised. This zone, a peak formed in October 2023 marks a significant barrier as it aligns with the upper bound of the descending channel and 61.8% Fibonacci retracement level. Hence, should prices persist below the 106.20 resistance zone, a retreat back to the initial support at 102.00 might occur.

Potential reversals and support levels

Looking at the recent price action over the past four weeks, prices on the lower time frames showed a bullish trend, marked by higher lows and higher highs, edging closer to the resistance zone at 106.20. While this suggests a short-term bullish momentum, caution is warranted as DXY approaches the upper boundary of the descending channel. Traders could keep a close watch on potential signs of a reversal such as a shift in market structure accompanied by bearish chart patterns such as three black crows or bearish engulfing candles. Should a reversal occur, 102.00 and 100.00 stand as pivotal support levels, where buyer interest might stall the price decline.

Potential breakouts

While the descending channel might put a lid on the upside potential of DXY, it is notable that a breakthrough above the 106.20 resistance zone could boost its bullish momentum. Such a move might send prices soaring towards the next resistance target at 109.20, which aligns with the 61.8% Fibonacci retracement level. Interestingly, this level served as crucial support during the October 2022 consolidation phase before the subsequent downtrend kicked in. 

Technical summary

In summary, DXY presents a nuanced trading scenario with both potential upsides and downsides. While a rebound from the support at 102.00 hints at an upward swing, caution is warranted near the resistance at 106.20. Traders could watch for signs of potential reversals, indicated by bearish displacement or bearish candlestick patterns. Support at 102.00 and 100.00 may play critical roles. However, bear in mind that a breakout above 106.20 could alter the bearish landscape. 

DXY Chart: Weekly timeframe

Fundamental perspective - medium-term market overview

Inki Cho - Financial Markets Strategist

Macro Analysis: Based on the U.S. Economic Situation

The current market scenario has been predominantly focused on the expected timing of the Federal Reserve's first interest rate cut. While the inflation rate is gradually declining, there was growing anticipation that the Fed may cut interest rates shortly. However, the legitimacy of the Fed cutting interest rates is being questioned as the United States economy continues to exhibit steady growth.

At this point, it is worth noting that the Fed's current monetary policy stance remains hawkish. In a recent speech, Cleveland Fed President Loretta Mester cautioned that inflation may not ease quickly and that the Fed’s interest rate cuts will likely progress gradually. Similarly, Minneapolis Fed President Neel Kashkari stated that the Fed's mission to curb inflation is still ongoing, emphasizing that the Fed has not yet achieved its inflation objective.

The Fed is currently exhibiting a sense of caution in light of the potential for renewed inflation risks, as positive economic data in the United States drives employment and prices back up. In fact, the US ISM service Purchasing Managers' Index (PMI) experienced a significant uptick in January from 50.5 the previous month to 53.4, reaching its highest level in the past four months since October last year. (A sudden increase in the January NFP has also raised concerns about the possibility of an inflation resurgence.)

As the current situation unfolds, there appears to be a gradual dilution in the market's expectations about the Fed's rate cut. As per the data from FedWatch, the probability of the Fed's first rate cut at the March FOMC meeting has plummeted to 21.5% from 64% a month ago. Additionally, forecasts from major Wall Street institutions for the timing of the first-rate cut have also continued to be pushed back.

Fundamental summary: Future direction of the dollar(DXY) from a macro perspective

The recent upturn in the US economy has exceeded the expectations of many and has been accompanied by hawkish remarks from Fed officials. These factors have contributed to a strengthening of the dollar, with the dollar index(DXY) reaching a high of 104.50 after Chairman Powell's recent restrictive speech on CBS. This marks the highest level since November last year and represents a significant rebound of nearly 4% from its low point in December.

Considering the macroeconomic landscape, it appears plausible that the US dollar will maintain its robust position against other currencies in the near future. The reason behind this hypothesis is the positive outlook for the US economy and the Fed's commitment to sustaining high benchmark interest rates over an extended period. These factors are significant drivers that are expected to uphold the dollar's strength.

In particular, the NFP exceeded the market consensus of 187K in January and surged to 353K, reaching the highest level since March last year. This development raises the possibility of better-than-expected employment, resulting in wage increases, posing a significant challenge to the conversion of the Fed’s monetary policy. 

As long as the robustness of the U.S. economy continues to be proven through the release of economic indicators, expectations of a Fed’s rate cut will continue to decline, which will add support to the dollar.

In that respect, the forthcoming release of the Atlanta Fed’s Q1 U.S. GDP data and Initial jobless claims this week will be pivotal in determining the future trajectory of the dollar. Should these two data sets validate the U.S. economy's strength and the labor market's buoyancy, the current strong dollar stance may persist for longer than market expectations.

Overall conclusion

The fundamental and technical analyses provide contrasting forecasts for the Dollar Index(DXY). While technical analysis sees a continuation of the current bearish trend with clear resistance and support levels, fundamental analysis suggests a potential bullish trend influenced by macroeconomic factors and the Fed’s monetary policy stance.

Which expert is right? Only time will tell. Whenever you are unsure about an asset, consider only acting when both schools of analysis are aligned. Also, keep in mind that with the right timing, both fundamental and technical forecasts may play out accurately, with perhaps a minor deviation.


This is not investment advice. Past performance is not an indication of future results. Your capital is at risk, please trade responsibly.


Author:

Paul Reid
Paul Reid

Paul Reid is a financial journalist dedicated to uncovering hidden fundamental connections that can give traders an advantage. Focusing primarily on the stock market, Paul's instincts for identifying major company shifts is well established from following the financial markets for over a decade.