March 15 (Reuters) – Betting against the dollar was one of investors’ favorite trades at the start of 2021, but the U.S. currency is now recovering and technical analysis patterns from recent years suggest it could recoup a third or, potentially, all of last year’s 13% drop.
Charts show the 2020 fall in the dollar index was similar in magnitude, duration and price patterns to a 2017 slide that was followed by a recovery. If history repeats, the dollar’s 34-month low in January could represent a bottoming that lays the foundation for gains.
This bullish technical potential was reinforced by this month’s surge in the U.S. currency, while interest rate moves, excessive dollar bearishness and macro-economic factors such as COVID relief spending by the government and an accelerating vaccination drive should add support.
Traders use technical analysis to examine chart patterns and past behavior of prices, which can make it self-fulfilling.
There are several similarities between the dollar’s COVID-driven losses from last March and its January 2017 to February 2018 slide: both lasted between 10 and 13 months and produced losses of 13-15% from peak to trough.
One significant parallel appears when the Elliott Wave theory, a technical analysis tool that identifies patterns of rises and falls in financial markets, is applied.
The analysis can help identify when a major trend, such as last year’s dollar fall, might change. To reverse the downtrend, the dollar must close above a key point previously hit in the cycle of losses and gains, and then confirm it by surpassing the next level.
The dollar index met the first condition by closing on March 5 above the first target at 91.737, opening the way for a rise to the next at 94.745, which will be key to confirming that the recovery is under way.
During its 2018 recovery it took the dollar five weeks to accomplish a similar move.
Once it confirms that the recovery has started, the next milestones would be 96.098 and then 97.725, which represent the 50% and 61.8% Fibonacci retracements of the March-January fall. Fibonacci retracements are statistical measures that traders use to identify major highs and lows, which often align with key Elliott Wave milestones.
The dollar could regain the bulk of that pandemic tumble if it follows the 2018 recovery pattern, which resulted in a 2020 high that was just shy of the 2017 peak.
To be sure, chart history doesn’t always repeat itself, so there is no guarantee that the dollar will follow the same bullish path it took in recovering from 2018’s low. While rising Treasury yields have supported its recovery, any indication that they are topping out would remove a key source of fuel for the U.S. currency’s rebound. For the moment, however, the U.S. appears to be exiting the pandemic, with the help of its vaccine drive, which should support yields.
One of the best things going for the dollar now is that so many investors are still betting against it, leaving them vulnerable to further gains that could force some to buy.
Speculative positioning against the dollar versus major G10 currencies hit 10-year highs in January and is still elevated, according to data released weekly by the Commodities Futures Trading Commission, while FX strategists remain roundly negative. Such excessive dollar bearishness is typical of major market bottoms.
Against the euro, the main component of the dollar index, dollar shorts have fallen from a record high of $31.3 billion high in August, but they were still worth $15.6 billion on March 9. They were at similar levels in April 2018, as the single currency entered a 15% slide.
Editing by Burton Frierson and Edward Tobin