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The Dollar Is Coming in Hot -- And That's Important for All Investors

An overbought reading like this has only been seen one other time in the last seven years.
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As we head into 2022, the dollar is coming in hot. This is the opposite scenario of December 2020 in which the dollar was trending lower and facing pessimism on all fronts.

The sentiment reading we monitor is currently pegging industry insiders at a 60% to 65% bullish tilt regarding the greenback. This means the majority of those polled are bullish and have likely already expressed their opinion in the market via long dollar or short currency plays such as the euro. Not surprisingly, only 25% of the same group is bullish on the euro.

These figures signal we could be nearing an overcrowded trade. Further, we have noticed a trend of significant trend reversals in the currency market at about the time the December futures expire, and the Fed meets for the last time of the year (in mid-December). Thus, much like we have seen in the past, the overwhelming consensus opinion heading into the New Year might reverse itself much sooner than the masses expect.

Even those who aren't interested in speculating in the currency market should be aware of the action in the major currency pairs. A stronger dollar acts as a headwind to risk assets and a weaker dollar opens the door to irrational exuberance.

Although late 2021 price action has seen many risk assets brush off the stronger dollar, in the long run the aforementioned relationship holds true. Accordingly, if the dollar finds a high in the coming weeks as we suspect, it could be supportive to crude oil, grains, and most of all, bullish for gold and silver.

Weekly ICE Exchange Dollar Index

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Source: QST

The ICE Exchange dollar index futures contract is running at an RSI (Relative Strength Index) above 70.0 on a weekly chart. Such an overbought reading has only been seen one other time in the last seven years; on that occasion, the dollar put in a major top on or around this time of year and never looked back. While we don't expect anything that dramatic, we do believe the upside is limited.

The dollar was able to break above technical resistance at 94.70/95.00 on news of a hawkish Fed seeking to raise interest rates but sometimes the Fed talks about rate hikes it never delivers. We have seen prices get comfortable within a band of resistance from 95.80 to 97.00, yet in the absence of "less talk and more action" from the Fed, or another unforeseeable fundamental change, we have a tough time seeing the dollar index hold above 97.00. Instead, we suspect a trip back to the low 90.00s is probable.

Keep this in mind as you navigate the stock and commodity markets. Also, be careful getting sucked into the strong dollar narrative; December/January currency reversals have been a relatively common occurrence in recent years.