Following the FOMC decision to raise the overnight interest rate to a target of 0.5% to 0.75% (a 0.25% increase) on Dec. 14 the U.S. dollar index has broken out, and the euro is also close to a multi-year breakout. If current momentum continues the euro could trade significantly lower over the coming year. On the flip side, if the U.S. dollar fails to rally at this juncture, it could indicate a substantial false breakout and a decline in the U.S. dollar over the next year (or longer). Currently, momentum favors U.S. dollar strength.
CurrencyShares Euro Trust (FXE) is trading at an all-time low as the EUR/USD currency pair approaches its lowest level since early 2015. If the EUR/USD moves below those 2015 lows it will be lowest price since early 2003. The 2015 low in the EUR/USD is 1.0461, with pair closing out trading near 1.0530 on Dec. 14. FXE has already moved below its 2015 low of $102.92, closing on Dec. 14 at $102.32. The Euro Trust has broken out, before the EUR/USD, because the trust charges a fee for its services (the expense ratio) which slowly erodes the value of the trust each year. This is important to keep in mind when trading ETFs, as expense ratios can sometimes obscure breakout levels. If in doubt look to the underlying asset, in this case the EUR/USD currency pair.
While the EUR/USD hasn’t broken below 2015 lows, this is still a critical juncture for the euro as it is right near the breakout point. Since the start of 2015 the EUR/USD has been trading in a big range largely contained between 1.16 and 1.05. If the price breaks below 1.0461 (and can sustain the breakout by continuing to move lower) the target is 0.94. That equates to $93.50 to $93 on FXE. If the U.S. dollar can’t sustain these levels and starts to drop (euro rise), the long-term range will continue with FXE likely rising back above $108 and the EUR/USD rising back above 1.11.
PowerShares US Dollar Index Bullish Fund (UUP) has also moved to a fresh 52-week high following the FOMC announcement, and is trading just below the 2015 high of $26.50. The ETF hasn’t quite broken above 2015 levels, but the underlying U.S. dollar index futures contract has. Dollar index futures are trading at their highest levels since 2003. The expense ratio of the fund slightly reduces the fund’s price each year, which is why it remains slightly below breakout levels. Ultimately though, if the dollar index continues to the upside so will the Dollar Index Bullish Fund.
Since early 2015 the Dollar Index Bullish Fund was moving in a descending channel. The fund broke above that channel on Nov. 14 when it gapped above $25.65. Since the channel was approximately $2 in height, $2 can be added to the breakout price providing a long-term target of roughly $27.65. A more aggressive target is $28.50 to $29. If the fund can’t move above $26.50, or can’t sustain itself above that level, then the long-term range could be continuing with the price expected to slide back below $25.50 and toward major support in the $24 region.
The Bottom Line
Sometimes ETF breakouts may not align with the underlying asset due to the effect of the fund’s expense ratio. This could mean an ETF breaks out before the underlying asset, or is delayed in breaking out relative to the underlying asset. Despite these slight discrepancies, the euro and the U.S. dollar index are at critical levels. If U.S. dollar strength persists the euro will continue to decline in alignment with its long-term downtrend. The dollar index is also near major breakout levels; if this breakout sustains itself the U.S. dollar could move higher by up to 10% over the longer-term.
Disclosure: The author doesn’t have current positions in the ETFs or futures contracts mentioned, but does day trade the EUR/USD currency pair on a regular basis.
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