The dollar has been hammered over the past month, losing 5.5% against the Euro and 4.5% against a basket of currencies reflected by the dollar index. The declines come as economic data continues to show that the US economy is contracting. US GDP contracted in the Q2 the most in its history, which has allowed the interested rate differential to ease against Euro. The technicals on the dollar index look horrible and are pointing to a lower dollar. Without a vaccine, the US economy is likely to falter, and growth should continue to stumble.
US Growth Contracts More than Europe
US GDP contracted by a robust –32.9% Q2 of 2020 but despite the record decline, it was less than expected. Estimates were for the US economy to contract by -34.5%. With the Q1 declining by 5%, the S is officially in a recession. On a quarter over quarter basis, the Q2 contracted by -9.5%. The declines in US growth compared to EU GDP which contracted by 12.1% quarter over quarter and 15% year over year. These levels were in line with expectations. This is also the strongest contraction on record in Europe.
The Yield Differential Moves in Favor of Europe
The terrible economic numbers that came out of the US, led to a decline in the yield differential when you compare the US 10-year yield to the German 10-year yield. The yield differential which helps drive the forward curve moved 4-basis points in favor of Europe during July helping to drive down the dollar relative to the Euro. Forex trading became a one-way street in July with traders jumping on the short-dollar train.
The trend points to a lower dollar, but the seasonals show that the greenback generally outperforms in August. During the past 10 years, the dollar has increased against a basket of currencies 70% of the time for an average gain of 0.3%. This compares to July where the dollar is down 60% of the time against a basket of currencies for an average loss of -0.3%.
The trend in the dollar is downward. The 10-week moving average has recently crossed below the 50-week moving average which means a medium-term downtrend is now in place. Target resistance is seen near the 2018 lows near 88.20. Resistance is seen near the 10-week moving average at 96.50.
Short-term momentum is negative as the fast stochastic continues to accelerate lower. The current reading on the weekly fast stochastic is 3.6, well below the oversold trigger level of 20, which could foreshadow a correction. The relative strength index also moved lower which reflects accelerating negative momentum. The current trading on the RSI is 32, which is on the lower end of the neutral range and just above the oversold trigger level of 30. In August of 2018, the RSI declined to 25, which means negative momentum can continue to accelerate.
The MACD (moving average convergence divergence) generated a crossover sell signal in July. The MACD histogram also sliced through the zero-index level which is also a sell signal. The MACD histogram is printing in the red with a downward sloping trajectory which points to lower prices.
The Bottom Line
The upshot is that there is further room for the dollar to decline. The COVID-19 virus continues to spread in the US which likely means that economic growth is on the back burner. Europe seems to have a handle on the virus and is beginning to rebound which points to an interest rate differential that will move in favor of the Euro. The technicals point to a lower dollar, that is poise to test the August 2018 lows.