When Joe Public, Mr Everyman and Uncle Tom Cobley are all united in their view of the market, it pays to take the other side of the trade. That's certainly been a profitable strategy with the US dollar over recent weeks. Small traders were negative to a man over the outlook for America's currency. Sentiment readings had reached pessimistic extremes. And then the dollar rallied powerfully.
If the dollar's revival continues, it is likely to be the decisive factor in the markets in 2010. Much of the rally in stocks and commodities in 2009 has been financed by investors borrowing cheaply in US dollars and sticking the proceeds into risky assets. And, as we argued on 11 November, when this process goes into reverse, those assets would come under huge pressure - see
The dollar's recent gains against the euro have been sharp. The euro bought $1.514 in early December, but that has weakened to just $1.425 inside 11 trading sessions. It experienced a move of similar proportions back in March, but that turned out to be a false dawn. But there are reasons to believe that this time may be different.
The flavour of the dollar's latest rally is distinct to that of previous up-moves in recent times. Whereas before, the dollar's gains tended to be shallow and choppy, the current effort is deep and thrusting. Such behaviour is typical of a genuine uptrend, rather than a mere corrective movement.
The reversal has taken the euro/dollar rate through a key level on the chart. For the first time since April, it has dropped through the daily Ichimoku cloud, the bottom of which currently sits at $1.462. As a result, the cloud is likely now to serve to prop up the dollar's gains, rather than to hold it back.
Even though the dollar has probably begun a new bull market with huge potential for gains, it is not going to be one-way traffic. With the euro having registered a daily oversold reading for the first time in more than a year, a decent snapback seems a likelihood fairly soon.
A typical 'second wave' correction such as this might typically retrace some two-thirds of its prior losses. It would be helpful for our bullish case if the euro didn't go through the top of the daily cloud, currently at $1.483. Once it exhausts itself, the coming bounce should create some excellent opportunities for short-selling.
Assuming our Elliott-wave interpretation is right, an even more powerful burst of dollar strength will follow the coming correction. Ultimately, we expect the greenback's new bull market against the single European currency to take it to well below $1.20. Along the way, important targets lie at $1.42, $1.38 and $1.32.
To accomplish all these objectives, this exchange rate will have to overcome some formidable obstacles. One important level to watch is the 55-week exponential moving average, which currently sits at $1.4244. A much bigger zone of resistance could come from the weekly Ichimoku cloud - which presently is located between $1.418 and $1.353.
While the euro/dollar rate and equity markets have tended to move together in recent months, the relationship has broken down just lately. The dollar's rapid rise has not been accompanied by the sort of weakness in the FTSE 100 and other stock markets that might be expected.
Our favoured scenario is that this divorce will persist for a bit longer. Our reading of the equity markets' charts is that they should rally a bit higher in 2010 before suffering renewed losses. In this sense, we expect the dollar's recent bottom to have been a leading indicator for the rest of the world's markets.
In the very near term, we are watching closely for pivot points in the euro/dollar rate occurring around 13 January and 26-28 January. The significance of these cycle-dates should become clearer closer to the time. If the euro/dollar rate falls going into them, they will be likely bottoms and if it rallies, they'll probably be tops.
