Dollar Drops to 6 Month Lows, What Next?

At the start of the North American trading session, the trade weighted dollar index fell to its lowest level in 6 months. The sell-off in the greenback drove the British pound to fresh 4.5-year highs and the New Zealand dollar to its strongest level in 2.5 years. At the same time, EUR/USD and USD/CHF are closing in on their 2-year highs. While it would be easy to attribute the weakness of the dollar to stronger external economic data, the broad based nature of the sell-off indicates that the move is also driven by the lack of desire to own dollars. The U.S. trade balance fall short of expectations in March, raising the risk of negative GDP growth in the first quarter. U.S. Treasury yields are also moving lower, a sign that investors expect the latest economic reports to limit Janet Yellen's optimism. The Fed Chair will be testifying before the Joint Economic Committee tomorrow and while there is no question the economy is recovering from the hard winter, the underlying weakness in labor force participation and low inflation will deter the head of the central bank from saying anything that could threaten the downtrend in yields. Remember, U.S. policymakers have made it a priority to keep rates low as they unwind Quantitative Easing.

Meanwhile everyone is talking about the major head and shoulders pattern in the Dollar Index that is shown in the chart below. If the dollar continues to fall and breaks through 78.85, there is no major support until 76 but this would most likely require 10-year Treasury yields to fall toward 2.5%. If Janet Yellen ignores the weak reports and talks about when rates could rise, the dollar index will bounce off 79 and move back above 80.



As much as the market may be focused on the dollar and where it is headed, there's still a significant amount of event risk for other major currencies this week. We are still waiting for the results of New Zealand's dairy auction. Tonight we have a speech from RBNZ Governor Wheeler on the impact of dairy on New Zealand's economy, NZ employment, Australian retail sales and Australian employment figures. Tomorrow Chinese trade numbers are scheduled for release and on Thursday we have the European Central Bank's monetary policy announcement. So as much as the major currency pairs will be driven by the market's appetite for dollars, external data such as this morning's solid U.K. PMI services report will also decide how the pairs trade.