The US Dollar index failed to follow through to the upside last week, as traders scaled back their expectations that the US Federal Reserve would start to taper its QE programme until at least December this year.
Further risk-on market sentiment and rising commodity prices helped boost riskier currencies against the US dollar. Strong German data also gave the single currency a strong boost, which is important as the euro currency makes up a significant basket of the US dollar index.
Most importantly, buyers failed to keep the post FOMC bullish momentum alive. This leaves the US greenback in a difficult spot this week as a massive head and shoulders pattern continues to loom over the US dollar index.
According to the size of the head and shoulders pattern, a breakdown rally of some 300 points could take place if the pattern is activated to the downside. Bulls desperately need to move the price above the 93.45 level this week to invalidate the large bearish pattern and avoid a technical meltdown.
The release of US jobs and manufacturing data is likely to set the tone for the greenback this week. Traders will also be on guard for the latest news about the United States massive infrastructure bill potentially being signed into law.
The ActivTrader market sentiment tool is showing that bearish sentiment has fallen back towards 68 percent. This is a solid drop-off in bearish sentiment, as some 93 percent of traders now bearish towards the US dollar index last week.
The drop in bearish sentiment is mildly bullish in the short-term, however, the risk of the US dollar index rallying is still high while bearish sentiment remains at elevated levels. Typically, I would look to fade sentiment skews above 65 percent.
At this stage, the one-way sentiment shift is likely to lead to further gains the for the US dollar in my opinion as too many traders are still way too bearish. Sentiment will probably need to neutralize before a major decline can commence.
US Dollar Index short-term Technical Analysis
Looking at the four-hour time frame bearish MACD price divergence has recently been reversed after the index ran into strong resistance and selling interest around the 92.40 price area last week.
Fibonacci analysis is leading the way in terms of the levels to watch this week. The US dollar index needs to break above the 92.50 to take out the 78.2 Fib retracement sequence, which is found by attaching the yearly low to yearly high.
Failure to break above the 92.50 area and I would expect the current up move to swiftly unravel, and for the index to head back down towards the 90.00 area again.
US Dollar Index Medium-term Technical Analysis
According to the daily time frame, a huge head and shoulders pattern remains the central focus for traders over the medium-term horizon. Whether the pattern survives or is invalidated this week is likely to determine the next 300 points move in the US dollar index.
If bulls can break the 93.40 resistance level then the US dollar index could surge towards the 96.40 area, however, if the pattern is not invalidated then we could see a sudden pullback towards the 91.40 area, at a minimum.