DJ FXCM Dollar Index

The Dow Jones-FXCM U.S. Dollar Index (Ticker:USDollar) is 0.50 percent higher from the open after moving 97 percent of its average true range, but we are likely to see the reserve currency consolidate over the next 24-hours of trading as the 30-minute relative strength index falls back from a high of 80. In turn, the index may work its way back towards the lower Bollinger Band around 10,002, and the USD may consolidate over the remainder of the week as European policy makers increase their efforts to restore investor confidence. However, as the fundamental outlook for the euro-area turns increasingly bleak, the flight to safety may gather pace going into the final days of 2011, and the USD looks poised to appreciate further in the following year as the Federal Reserve softens its dovish tone for monetary policy.

As the FOMC carries its current policy into 2012, it seems as though we will see the committee continue to carry out operation twist over the coming months, and we may see the central bank talk down speculation for another large-scale asset purchase program as Fed officials see the economic recovery gradually gathering pace next year. As speculation for QE3 diminish, it seems as though the central bank is a step closer in concluding its easing cycle, and the Fed may show an increased willingness to start normalizing monetary policy in the latter half of 2012 as the fundamental outlook for the world’s largest economy improves. As a result, we are still looking for a higher high in the dollar index, and the recent advance in the USD may turn into a longer term trend as the central bank strikes a less-dovish outlook for monetary policy.

The USD advanced against all of its major counterparts on Wednesday, led by a 1.01 percent decline in the Australian dollar, and the high-yielding currency is likely to weaken further in 2012 as market participants see the central bank taking additional steps to shore up the isle-nation. According to Credit Suisse overnight index swaps, investors are pricing the benchmark interest rate to fall by nearly 125bp over the next 12-months, and the AUD/USD looks poised to weaken further in the following year as it carves out a lower top in December. In turn, we should see the exchange rate continue to retrace the rebound from 0.9386, and the pair may end the year even weaker as we’re looking for a lower low in the exchange rate.

--- Written by David Song, Currency Analyst

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