Trader MD

I've noticed that lately a lot of people have been paying more attention and concern towards the US Dollar. So I've decided to take a technical look at it.

Usually, Wall St is a bunch of crack fiends that simply can't get enough rate cuts, but now they've shifted their focus and started whining about the dollar (it's about time).

First, let's start by taking a look at a long term US Dollar chart.



As you can see we've been a severe prolonged downtrend on the dollar. Also notice that we're still no where near that downtrend line and that multi-month/week rallies have taken place in the dollar before.

Are we at the bottom? I have no idea, but it does look like we're shaping up to put in a short term rally on the dollar (more on that later).

Now lets take a look at the relationship of the dollar to the $SPX.



As you can see the market has gone through periods of trading with and against the dollar. What's the exact relationship between those periods? I'm not entirely sure yet, but what is important to realize is that right now we're in a period where we are trading *with* the dollar.

Note: Periods in which we trade with the dollar are highlighted in blue & against the dollar in red.

Now, lets take a look at the recent action in the dollar.



The dollar has recently broken out to the upside of this descending triangle formation. We have an upside target of ~74.25, based on the height of the triangle.

It's still too early to tell if this is the absolute bottom in the dollar, but it does appear to be setting up for a short term rally, if nothing else.

Let's take a look at what the big money has been doing (wow, look @ that volume increase -- there's no other way to explain that kind of volume jump).



The big money is clearly getting long the US Dollar ahead of the Fed. Either they know something, or have seen something.

One odd thing/divergence I noticed today: Despite the strength of the dollar, the Russell 2000 was weak all day (strength in the dollar is in theory good for small cap stocks).

Now how does this all add up to the tomorrow's Fed meeting and how can we play it?

As I've pointed out in chart #2, the charts are telling me we're in a period where the market is trading with the dollar. Tomorrow's Fed decision obviously plays into not only the stock market, but also commodity, bond and most importantly currency markets.

Provided we get no more than a 25 basis point cut (that's what the majority of the Fed Funds future index is predicting) and language that suggests the Fed is done easing for a while, or that they are going to take the time to see the effects of the rate cuts they have put in place and will be ready to act if further action is needed:

• The dollar should rally
• In turn the stock market should rally as well
• While commodity and bond markets sell off (yields rise)

Now, there are other possibilities of course, and we should be ready to act upon them:

• The Fed could cut 50 bps and now I'm just guessing, but that may spook the market (What else does the Fed see out there? Don't they see inflation is creeping up? What about the dollar? Haven't they been paying attention to Volker, Greenspan, etc?)
• The Fed could stand pat (which would be very bullish for the dollar, etc)
• The news is already baked into the cake (always a possibility to be prepared for)
  
• Some unforeseen scenario (another possibility to be prepared for)

Speaking of the Fed and its action tomorrow. Keep in mind that they have seen the data for the rest of the week. If we get 50 bps tomorrow, then most likely the data we see for the rest of the week will be bad.

All that being said, I still expect the 15 minutes before and the 15 minutes after the interest rate decision to be very choppy and emotional.

I've got 2 swing positions I'm holding into tomorrow's Fed decision and as far as day trades go I will be completely flat by 2 pm EST.

In case you were wondering, my 2 swing positions are basically related to the short term dollar rally I was talking about. I'm long DZZ (double inverse of gold) and DUG (ultra short of DIG). I will be ready to close out these position on a whim's notice if the Fed action, statement, or market reaction isn't what I'm looking for.

Here's a link to: the Head & Shoulders type pattern I mentioned in Gold earlier today.

Good trading out there. We'll see how my analysis of tomorrow's Fed decision pans out.

Posted by Trader M.D. at 10:46 PM

Labels: Dollar, Fed, Gold, Index, Oil