Aquick glance at the US Dollar Index chart shows that the greenback has been on a significant downtrend this year. From the peak of about 103.70 in late December 2016 to the August low of 91.50, the dollar's retreat has reached nearly 12%.

 

Closer observation leads us to conclude that the downtrend can be divided into three segments, with the steepest descent from late June till the present. From my perspective, this precipitous decline combined with price levels derived from current market sentiment, should be indicative of upcoming key resistance or support levels of the greenback and existing focal points of the market.

 

In previous editions of China Forex magazine, I wrote that market sentiment could be one of the key factors in any reversal of a trend and might become a new market driver. It might also be worth noting that if the reversal were indeed established through market consensus, price levels that were marked by the abrupt change of market sentiment (which should also be seen as the initial point in the trend) would likely be tested in future market events and ultimately become key resistance/support levels.

 

If such recognition were indeed made and these levels were broken, investors would be observing a transition whereby support levels become resistance points or vice versa. By recognizing initial levels due to changes in market sentiment coupled with the phenomenon just mentioned, investors should be able to readily identify or filter out price levels that were deemed significant. By following this line of thinking, investors should be able to capture market insights underlying pivotal points that were deemed important. A simple review of the price action of the ICE dollar index below, illustrates this. 

 

Support and Resistance 

 

If we look at trading on the day Donald Trump made his surprising electoral win in November last year,  the ICE dollar index rebounded from the lows of 96.00 and closed near the day high of 98.65. As the results of the election became clearer, market sentiment changed from risk averse to risk loving. Evidence of this was also seen in the intraday trend of gold and dollar-yen.

 

Fast forward to mid-June of this year when the US Federal Market Open Committee announced its second rate hike of 2017. The ICE dollar index subsequently rebounded from 96.05 and a double bottom was formed as the market showed resilience at levels depicted by the intraday low hit on the day of the US presidential election.

 

However, the double bottom formation was subsequently broken when Mario Draghi, president of the European Central Bank, spoke at a forum in Portugal late that month. Not only did he highlight the recovery and financial stability in the European region, more importantly, he also relayed the message that the ECB’s monetary policy might become less expansionary. The significance of this will be touched on later in the article, but suffice it to say this hawkish message propelled the euro through its seven-month ceiling of 1.1300 dollars. This coincidentally was the intraday high reached on the day of the US election. This series of events led the ICE dollar index to penetrate the recently formed double bottom, and start its deepest descent of the year.

 

In a nutshell, the 96.00 level of the ICE dollar index should be marked as a key support level from the fourth quarter of 2016 to the middle of the second quarter of 2017. It is also worth noting that from a technical perspective, on July 5, both the ICE dollar index and the euro-dollar demonstrated shifts of support to resistance and resistance to support at levels of 96.00 and 1.13.

  

Though there is a spectrum of reasons behind the bearishness towards the dollar this year, the steepest plunge of the ICE dollar index occurred shortly after the Federal Open Market Committee's second rate hike in 2017 (after breaking the 96.00 level). A closer look into the events of the last two weeks of June should help calibrate the abnormality of the dollar's trend and the factors that caused the weakening of the greenback.

 

Convergence of Global Monetary Policy

 

In late June Fed Chair Janet Yellen, speaking in London, expressed a rather hawkish view on the outlook for the global economy. Besides assuring the public there shouldn’t be another financial crisis in her lifetime, she also reiterated that the Fed would most likely continue its gradual increases of interest rates. The dollar, however, did not strengthen on the news.

 

In hindsight, the market probably was not overly complacent at the time. Rather, it was probably focusing on the future monetary policies of the central banks of the other G7 countries that were revealed later in the week. The market deemed the comparison between monetary policies of different central banks to be of far more consequence after the Fed carried out its second rate hike of the year. One reason for the market's adoption of this timeframe in a search for comparisons should be seen in conjunction with the message sent in early 2017 by the Fed. Back then, Federal Open Market Committee members hinted that three interest rate increases were likely this year, though a significant number of market participants thought that two hikes should be sufficient.

 

 In addition, market participants seemed to have gained the upper hand against the Fed in rate hike expectations as the market consensus calculated from the Chicago Mercantile Exchange just before the announcement of the August non-farm payroll data put chances of a rate increase by the year-end at only 2% and less than a 40%. Expectations of a hike in September were 0%.

 

Therefore, it should come as no surprise that the market would consider abandoning its bullish expectations towards the greenback when other pillars of the world economy were moving to tighten monetary policy. In layman’s terms, the Fed was starting to decelerate, while the others were starting to put their foot on the interest rate gas pedal. And this was exactly what happened. 

 

European Central Bank

 

As mentioned above, Mario Draghi's hawkish speech in June drove the euro above the key 1.13 dollar level. Afterwards it rolled up a more than 700-pip gain, appreciating about 7% against the US unit. Mark Carney, governor of the Bank of England, also reiterated that removal of some monetary stimulus by the central bank might be conceivable if UK wages continued to pick up. That resulted in the strongest rally by sterling since April 18, the day that Prime Minister Theresa May called for a snap general election. Carney’s stance echoed the voting results announced by the Monetary Policy Committee earlier in the month. On June 15, although in favor of no interest rate changes, the voting was a three-to-five split, with three votes in favor of a rate hike. This clearly indicated the existence of internal debate over a rate hike among the committee members of the Bank of England, and suggested the dovish governor might be leaning towards the opposite side. 

 

Bank of Canada

 

Bank of Canada Governor Stephen Poloz on June 28 also said in an interview that the 50-basis-point reductions in interest rates in 2015 seemed to have “done the job” in reviving the Canadian economy. He also described the first quarter of 2017 as showing surprisingly strong growth, as Canada reported a 3.7% annualized economic expansion over the period.

 

Lynn Patterson, deputy governor of the Bank of Canada, was completely in sync with the governor