Should You Chase the U.S. Dollar’s Rally?

The U.S. dollar rallied 6% higher since early May, which is a really big move in such a short amount of time for the world’s largest currency.

The Wall Street Journal took until last weekend to put the rally on its coveted front page, where the cover headline reads, “Resurgent Dollar Fuels Rally.”

One of the main points of the article was how the dollar rose nine weeks in a row to break a 17-year record.  Why did the WSJ just now catch on to the rally that has been going on for five months?

Contrarian Investing

The smart investor is aware of sentiment and contrarian signals (such as our subscribers) and thus has reason to expect at least a short-term relief pullback or stall in the dollar’s rally (and euro’s decline).

Now that the public is fully aware of the dollar’s recent trend, investors are likely the last to know and likely now buying into it at exactly the wrong time (after an already strong 6% gain).

Thanks to the chart below, we were fully prepared for and are now not surprised at the dollar’s rally and euro’s decline while mainstream media was very bearish.

u.s. dollar euro

Technicals and Sentiment Support a Short-Term Pullback

Our February newsletter warned, “A breakout of that pattern…would cause 10 years worth of bears to realize they are on the wrong side of the trade, eventually joining the bulls in buying back their shorts.”

We are certainly starting to see the bearish turn bullish now as the WSJ pointed out the “nine weeks in a row of gains.”

Back in February, bullishness on the euro by retail investors, traditionally considered the dumb money, was also back at similarly elevated levels that coincided with price highs at $1.45 for the euro (FXE) in 2011. I reiterated the same stance in my April 3 research piece “Is the Euro About to Tank?” and discussed the extremes conveyed in the chart below.

u.s. dollar euro

In an opposite extreme, our Sept. 14 Technical Forecast showed that speculators have also jumped on the recent euro selloff and are now as short as they were during previous Euro bottoms. Similarly, the WSJ headline, the technically overbought readings, the Federal Open Market Committee minutes and the Scottish independence referendum all lead me to suspect that the euro’s decline will stall soon with a brief rally of relief.

The U.S. dollar has just started a likely long-term advance, but given the euro extremes, a pullback will probably first interrupt the dollar’s rally.

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