The US dollar is looking a little overbought

Photo: Keystone Features/ Getty Images.
  • The US dollar index (DXY) has rallied nearly 5% since mid-April.
  • The speed and scale of the bounce has left the US dollar looking overbought on a commonly-used, momentum-based indicator.
  • The last three times the USD was this overbought it heralded the start of a pullback.

The US dollar has been on a tear in recent weeks, rallying close to 5% since mid-April.

Such has the scale and speed of the rally been, it’s left the US dollar looking a tad overbought against many currencies, both for majors and in emerging markets.

This chart from Nomura shows how overbought the US dollar is against various crosses using a 14-day relative strength index (RSI).

Source: Nomura

“Currently around 70% of USD crosses in all DM and EM are now above the 70 RSI (14d) overbought level,” Nomura says.

“This has happened on only three occasions over the past few years — November 2016, May 2016 and in March 2015.

“On each of these occasions USD correction ensued, and was worth 4-6% over the following two to three months.”

A RSI value above 70 indicates that an asset, in this case the US dollar, is becoming overbought or overvalued, and at risk of a potential reversal. As a momentum indicator, it suggests the move has been quite abrupt compared to average.

Importantly, it does not mean that an imminent reversal will happen.

Based on recent history, Nomura says it suggests “markets can only stomach a certain amount and a certain pace of broad-based USD strength”, adding that it is approaching that limit at present.

“Whether this will result in a temporary pause or moderate correction in the USD, or a larger retracement of more than 5%, will likely depend on external factors,” it says.

Nomura nominates trade talks between the US and China, Fed interest rate expectations and the direction of the EUR/USD as possible catalysts that could determine if the US dollar consolidates upon recent gains or reverses.

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