Chart of the Day: Dollar Tests Major Support Area Ahead of New Year

• Hawkish Fed means downside limited for dollar
• Greenback could find support on haven flows
• Dollar Index inside massive long-term level

The US Dollar remained under pressure in the first half of the last trading day of the year and was set to end 2022 on a downbeat note after its stellar performance peaked in September. As we look forward to the new year, I reckon there is a good chance for a comeback, as the Dollar Index (DXY) tests a key support area amid a still-favorable macro environment for the greenback.

Before discussing the macro backdrop further, let’s take a quick look at the DXY’s long-term weekly chart, below:

While there were no signs of a comeback for the dollar at the time of writing, the DXY was inside a major long-term support zone in the shaded region on the chart between 101.95 to 103.80. The upper end of this range marked the highs made in 2017 and 2020, while the lower end is the 50% retracement against the entire upward move of the last 2 years or so. Therefore, there is the potential we could see a major recovery for the dollar.

But we have to see a reversal stick first, such as the formation of a hammer candle within this above long-term support zone, or some other form of confirmation – for example, a break above the most recent short-term high around 105.23.

The dollar’s drop from the end of September has been due to signs of US inflation peaking and the resulting expectations that the Fed is going to pause its rate hikes soon, having already reduced the pace of tightening to 50 basis points at its December meeting.

But the Fed has indicated that interest rates are going to remain high, for longer. At that December meeting, the FOMC signaled that interest rates could rise to and remain at 5.00%-5.25% in 2023, with the Fed Chair Jerome Powell also pushing back against market talk that inflation is on a sustainable downward path. The fact that this led to a renewed stock market sell-off at the same time means there is the potential for the greenback to find support from haven flows, especially against high-beta commodity dollars, if the risk-off environment does not change.

Elsewhere, support for the dollar might be provided by weakness in foreign currencies. Among these is the British pound. I reckon cable is going to fall back and remain below the $1.20 handle for a while. The pound should remain under pressure against most major currencies, owing to a sustained period of subdued economic activity. Two of the Bank of England’s rate-setters voted against the 50-basis point rate rise of the majority at the last MPC meeting. The split in the MPC should become more pronounced as the double-digit UK inflation continues to hurt pockets of consumers and weigh on business activity in H1.

So, watch out for a possible dollar reversal as we look forward to the start of the new year. Conservative traders should wait for the bottom to form, before potentially looking to enter any bullish dollar trades. I favor shorting the GBP/USD or commodity dollars.

Happy holidays.

Disclaimer: The author does not own any of the securities mentioned in this article.