Dollar correction potential

The US dollar looks rather fatigued and we think it may be set for a correction of some sort in the coming days. After a three-month rally, the Dollar Index is flat so far in July and with just one more day of the month left, we can’t see it staging a late rally now. Undoubtedly, the dollar’s hesitation this month is largely due to profit-taking after it rose sharply in the previous months on the back of stronger macro data, which cemented expectations that there will at least be two more rate hikes from the Federal Reserve before the year is out. Now it appears as though that the bullishness is priced in, as indicated, for example, by the dollar’s lack of positive response to stronger incoming US data. Indeed, not even news that the world’s largest economy grew 4.1% annualised in the second quarter – which was the best reading since 2014 – was enough to lift the reserve currency out of its recent tight range on Friday. Instead, the DXY closed lower and once again frustrated the bulls.

Meanwhile pockets of strength in some other currencies may be another factor dampening the appetite for the dollar. The Canadian dollar, for example, has shown relative strength of late owing to a hawkish central bank, positive domestic data and firmer crude oil prices last week. But ongoing NAFTA uncertainty has capped the upside for the Loonie. Meanwhile, there is a lot on the agenda this week which could lead to significant volatility in the major currency pairs, potentially providing plenty of tradable opportunities. With the Bank of Japan and Bank of England on the agenda, we could see the pound and yen coming into increased scrutiny, and possibly with positive outcomes. So the dollar could ease a little against these currencies in the short-term outlook.

The dollar correction potential is supported by some technical signs of weakness on the daily chart of the Dollar Index, especially around the 95.50 key resistance level. Here, a false break reversal pattern may have been created when the bulls staged an unsuccessful breakout attempt on July 19. On that day, the DXY created an inverted hammer candlestick pattern and since then we have seen some bearish price action and acceptance below that key 95.50 resistance. The bears now need to see a decisive break below short-term support and bullish trend line around the 94.30 level. If this were to happen then they may start targeting the liquidity pools below the previous lows at 93.71 and 93.19, with the next untested horizontal support coming in at 92.65.

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