What we learn from an in­dex

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

Financial Mail - Investors Monthly - - Contents -

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.

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