Dollar Strength Reflects A Change In Investor Mood

By Jim Donnelly, Olson Global Markets

Although the S&P 500 Index broke slightly above key trend line resistance at 1,130 and the Dow Jones Industrial Average nudged a bit above key resistance at 10,660, neither index was capable of stoking up buyer momentum and extending much higher. On the contrary, shifting political winds and the recognition that the rally since March needed to take a breather resulted in a “sell into strength” approach instead. Although the BKX financial ETF continues to form what appears to be a bullish reverse Head & Shoulders pattern and with the Dow Jones Utility Index backing modestly away, but not far from key trend line resistance at 408, it might well be the DXY dollar index that more accurately frames the change in investor sentiment that currently has both commodity and equities prices turning lower.

No doubt, the political landscape changed quite a bit last week. A stunning senatorial upset in Massachusetts became a glaring piece of evidence that health care reform may be forced to take a different direction. Another unexpected development was the realization that the reconfirmation of Fed Chairman Ben Bernanke may be in jeopardy. Additionally, the rolls of Treasury Secretary Tim Geithner and the Director of the White House’s National Economic Council Larry Summers have become cloudy. Further, big banks have become politically targeted with the announcement of the “Volcker Plan” which is designed to restrict the size and activities of the largest U.S. financial institutions.

Internationally, Chinese banking authorities have instructed some of their major banks to halt lending activity during the rest of January after a burst of credit expansion occurred in the first couple of weeks on the New Year.

What has all of the done? At the very least, it has induced money flows into the U.S. dollar as well as into U.S. Government bonds which was evidenced by the U.S. Dollar Index (DXY) spiking higher and breaking above another form of trend line resistance at the 77.90 level. With many technical indicators on weekly charts positioned bullishly, the likelihood for further dollar strength appears assured. A modest Fibonacci 38% retracement targets a move up to the 80 level on the DXY. A 50% correction sits at 81.80. A more likely outcome, however, might be a 61.8% retracement up to the 83.70 area. Not only does that level represent a Fibonacci number as well, it would also fit the character of the “C” leg portion of a corrective A-B-C “zig-zag” pattern.

If this scenario plays out however, it will likely keep both commodity and equity prices on the defensive for a while longer.

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