What we learn from an index

For now the higher probability outcome looks to favour a stronger dollar

The US dollar index tracks the US dollar against a basket of other developed market currencies, and is a broad measure of how the dollar is performing against those currencies.

The biggest weighting in this index is the dollar euro cross, which accounts for 57% of the index. Other currencies that form part of the index are the yen (13.6% weight), pound sterling (11.9% weight), Canadian dollar (9.1% weight), Swedish krona (4.2% weight) and the Swiss franc (3.6% weight).

The US dollar index is watched closely to measure its broad strength or weakness among its global peers. The dollar has been strong in recent years but has been range bound since the start of 2015 between 93 and 100. There is much debate at the moment as to whether the dollar’s strong rally of the past few years is drawing to an end, or whether the sideways consolidation of the past year and a half is just a sideways continuation pattern within the broader rising trend before another break to the upside.

The jury is still out but from a technical perspective there has been a clear weekly reversal up from the bottom of the range at 93. Goldman Sachs recently made a bold call that the low for the dollar for 2016 is now in and that they expect the dollar to strengthen by up to a further 15% off the recent low.

From a technical perspective, if the reversal up from the 93 range low is able to remain unchallenged then it’s quite possible that the low may be in for the foreseeable future.

A break above 94.5 will mark a break above the downtrend that has been in place since the start of 2016 and that would point to further dollar strength. A convincing break below 93 on the dollar index would, however, be a bearish break and would point to further weakness for the dollar. For now the higher probability outcome looks to favour a stronger dollar. he VIX index is the Chicago Board Options Exchange volatility index. It refers to the level of implied volatility on S&P500 options.

It is also commonly referred to as Wall Street’s “fear gauge”. The reason for this is that market volatility increases during times of market fear and decreases during times of calm.

In January and February this year the S&P500 started the year on a weak footing and consequently the VIX traded up at around 28. The market has since calmed down and volatility has receded, resulting in the VIX moving down to around 13.

The VIX seldom goes much below 13, so the current low volatility is unlikely to drop further. But it certainly could move higher at any sign of a wobble in the equity market.

The VIX chart seems to be forming a rounding base pattern. Lateral resistance on VIX is at 16 and a break above that level would be a bullish breakout for VIX, which would imply increasing market volatility. A break above 16 would open a minimum measured target of 20. VIX always moves higher during times of equity market weakness, so a break higher in the VIX index would imply a correction in equities.

Markets often hit a bumpy time in May and June. The saying “sell in May and go away” is relevant in that respect. Keep an eye on the VIX index in the near term for any clues to rising market volatility. A break above 16 on VIX will imply a period of weakness for the equity markets which would not be uncommon for this time of the year.