“Blast-off” Level for US Dollar Index

03/15/2012 6:00 am EST

Focus: FOREX

Another downside test in the US dollar index would not be surprising, but if a close above the 80.25 level takes place, the index could blast off, writes Cody Tafel of Minyanville.com.

The currency markets have remained volatile, even while equities continue to grind higher, and it seems like there could be an interesting move coming for the US dollar index (DX).

It looks like the bulls have been shaken out (including me!) on the moves below 79 in the past month, and we need to watch how the DX acts above 80 to see if the momentum can continue.

We have rallied two points off the late-February low, so we might take a breather here, and I would not be surprised to see another downside shakeout. However, if we start to see the DX close above 80.25, then it might just start to blast off on the upside!

See the set-up below, and notice the positive divergence on the late-February low. I would also keep a close eye on the bond market here, as US yields seem to be trending higher in the short term.

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Even while I think the longer-term trend is shifting in favor of a stronger US dollar, there are some currencies that look like they could hold up well at these levels. In particular, I think the set-up in the Australian dollar is very interesting here.

Right around 1.05, I think you can buy the Australian dollar with a tight stop using the 200-day moving average below at 1.04. A move back up to last year’s highs would mean 1.10 or higher, so you clearly have a favorable, five-to-one reward-to-risk set-up at current levels. I’ll take that trade any day, and I’ll know to switch to the short side if it breaks 1.04.

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One of the biggest trends so far this year in the currency markets has been the breakdown in the Japanese yen, and this is really the main reason the US dollar index has been able to get back above 80.

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All of the commodity currencies (AUD, CAD, and NZD) are strong relative to the US dollar, and even the euro and British pound have improved from a short-term perspective, so this highlights just how quickly the Japanese yen has rolled over.

I would wait for a sharp rally to short the yen again, but I wanted to point out the nice trend here because that is what we are trying to find. Trade well and carefully out there!

By Cody Tafel, contributor, Minyanville.com