At the beginning of 2018, the dollar index weakened. The index has a fifty-seven percent exposure to the euro currency but reflects a diverse group of foreign exchange instruments against the greenback. The index closed 2017 at 91.98 and moved to a low at 88.15 in mid-February where it found a bottom and began making higher lows and higher highs reaching a peak at 97.705 in December. 2018 was a bullish year for the dollar.
Interest rate differentials can play a significant role in the path of least resistance of the dollar against other currency instruments. At their final meeting of 2018, the US Federal Reserve hiked the short-term Fed Funds rate for the fourth time of the year to the 2.25-2.50 percent level. With short-term European rates sitting at negative forty basis points, the spread between the yields of the dollar and euro currencies rose to 2.65-2.90 percent.
The widening differential between euro and dollar short-term interest rates should have added some bullish winds to the sails of the dollar index at the end of last year, but in the aftermath of the Fed decision, the index moved lower, and the selling has continued into early 2019.
As the weekly chart highlights, the dollar index peaked at 97.705 in mid-December but fell after the Fed hiked interest rates. When a market should rally for fundamental reasons, and it fails to do so, it tends to reveal underlying weakness. The nearby futures contract closed 2018 at 95.585, and after a rally on the first trading session of 2019 that took it to 96.56, it posted declines over the next three sessions and settled at 95.228 on Monday, January 7. Medium-term technical metrics are pointing lower.
Aside from interest rate differentials, the trade dispute with China, volatility in the stock market, political discord in the United States, and an ongoing government shutdown in Washington DC that is now in its third week is weighing on the value of the US currency. A weakening dollar contributed to gains in many commodities prices which got off to a bullish start in the New Year. Most notably, the price of gold has rallied and traded above the $1300 per ounce level on January 4 for the first time since June, and the price of crude oil recovered from a low at $42.36 on Christmas Eve to trade at over $49 per barrel on January 7.
Many signs point to a year of volatility in the currency markets. An emerging financial crisis in Turkey is posing a threat to many of the European banks that have exposures to the Turkish banking sector in their loan portfolios. At the same time, with the deadline for a final deal on Brexit on March 29, 2019, the euro and British pound could be in for a period of heightened price variance. In the US, Fed Chairman Jerome Powell seems to have taken a step back from his hawkish rhetoric when it comes to monetary policy in recent statements which could be adding to the weakness in the dollar versus other world currency instruments.
A volatile year in the currency markets could present market participants with lots of opportunities over the coming days and weeks. Meanwhile, the value of the dollar has started 2019 on a negative note. The first technical support level to watch on the weekly chart is the September low in the dollar index at 93.395 level. At 95.228 on January 7, the index is now trading just below the midpoint of the support level and the December high. I will be watching the support and resistance levels over the coming weeks for signs of a developing trend in the dollar as we move forward in 2019.