The Dollar: Things Are Getting Scary… Again

By Vadim Pokhlebkin
Elliott Wave International Forex Focus

If there’s a theme to the stories in the forex media this week, it can be summarized in one sentence: “The world is finally waking up to the dollar’s weak fundamentals.”

It is certainly starting to look scary for the buck. Today, the euro/dollar exchange rate broke above $1.32 – a level not seen in two years. What’s more, “While the economic data remain soft, the dollar will continue to fall,” say the analysts (Financial Times).

Wait, weren’t they saying the same thing in December 2004, when the EURUSD stood at an all-time high of $1.356? Yes, that’s exactly what they said – and we all know what happened next. Defying the “crash and burn” forecasts, in 2005 “the greenback enjoyed its best year against the euro and yen since 1999 and 1979 respectively” (WSJ ). So unexpected was the 2005 rally that even Warren Buffet, the Sage of Omaha, who famously bet “$20 billion or so” against the buck that year, was caught off guard by its sudden and sustained turnaround.

The USD rebounded in 2005 not because its “fundamentals” suddenly improved. On the contrary, the enormous U.S. trade deficit – the “biggest threat to America’s economy” – only got worse in 2005. The dollar rebounded that year because the market’s collective psychology went to an absolute dollar-bearish extreme in late 2004 – and then had nowhere else to go but the opposite way.

That’s why I wouldn’t place too much faith in the dollar’s “weak fundamentals.” Perhaps recognizing their limited impact on the dollar’s trend, even the FT this week attributed the “the dramatic dive of the US dollar” to “the power of round numbers” – a technical market indicator…

Yes, it pays to pay attention to technicals, and more than the media would have you believe. It was technical analysis of the EURUSD – namely, Elliott wave – that as early as Nov. 09 allowed EWI’s Currency Specialty Service to make this forecast for the recent rally in the pair:

Posted On: Thu, 9 Nov 2006 00:17:00 GMT. EUR$ is within a week or two of starting a thrust higher that will carry above 1.2798. Measured objectives lie at 1.3140, where wave five will equal wave one, and 1.3286…

What turned our forex analysts bearish the USD on November 9 wasn’t its “fundamentals” – it was that contracting triangle pattern you see in the chart above. So far, the EURUSD has only hit – and surpassed – our first target, $1.3140. Will it break the second one, $1.3286? We’ll know soon enough…