The US Dollar Is On A Tear So What Could Go Wrong?

The US dollar is on a tear and is validating the prophecies of the US dollar bulls. This morning's ADP employment report came in with a healthy gain of 218,000 jobs but below the consensus forecast of 230,000. The US GDP report was stellar. The 4.0 percent annualised gain for Q2 handily beat the 3.0 percent forecast. Many of the FX majors have seen technical breakouts including USDJPY, AUDUSD and USDCAD. The USD rally has traction and it only needs the High Priestess of the Federal Open Market Committee (FOMC), Janet Yellen, to bless the move.

Chart: US GDP growth


FOMC-rally enabler or wet blanket?

Traders are eagerly awaiting today's FOMC statement and seem to be expecting enough tweaks in the policy statement to validate the recent US dollar rally. They may be disappointed. It is the middle of the summer with three more months before the end of the asset purchase programme. There haven't been enough significantly strong data releases since the last meeting to warrant changing the wording of the interest rate guidance: "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run". The old adage that "those who ignore history are doomed to repeat it" may be applicable today. Last summer at this time, the FX markets were in a lather about the pending announcement of the start of the tapering programme. In fact, September tapering was believed to be written in stone and the discussion was only about the size and splits for tapering. We all know what happened then. Even a mildly disappointing FOMC statement could spark a nasty, profit-taking US dollar sell-off.

It's going according to plan so what could go wrong?

The current US dollar rally has taken on an aura of being pre-ordained in the sense that, because it has been widely predicted, the pending policy meeting and nonfarm payrolls reports will validate the optimism. What could go wrong? Friday's nonfarm payrolls report is forecast to show a gain of 235,000 jobs. Today's ADP report missed, yet the miss was dismissed. Today's GDP report is promising but as the Bureau of Economic analysis (BEA) noted in its statement "the second-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency". As stated earlier, a benign FOMC statement would put a damper on the rally, as well. The US dollar index has rallied sharply over the past few weeks but appears to have stalled in the 81.50-60 area, one that has contained rallies since November 2013. The upcoming events suggest to me that the risks are skewed to the downside in the short term.

Chart: US dollar index-Daily


USDCAD technical outlook
The short-term USDCAD technicals are bullish while trading above 1.0770 with the breach of the 200-day moving average at 1.0835 pointing to further gains toward 1.0950, the June peak. Above 1.0950 puts the cross-hairs on 1.1025, the 61.8 percent Fibonacci retracement level of the March-June range. In addition, the termination of the March downtrend from 1.1270 suggests that a short- term bottom is in place at 1.0730. Intraday, support is at 1.0835, 1.0810 and 1.0790. Resistance is at 1.0910, 1.0925 and 1.0950.

Chart: USDCAD 4-hour with target