Why the Dollar Rebound Won't Last

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The recent rebound in the U.S. dollar has markets questioning just how strong and reliable is the rebound in the dollar index?

The strength or weakness of the US dollar is currently influenced by two features. The first feature is the continuation of quantitative easing in the United Sates, which should lead to weakness in the currency. The second feature is the looming showdown on budgets and automatic spending cuts, known as the sequester, which kicks in March 1. This uncertainty will also help weaken the US dollar.

Both features suggest that the current rally in the US dollar index is temporary.

The weekly chart of the dollar index shows a long term head and shoulder reversal pattern. This is a long term pattern that developed over 12 months. The left shoulder developed in 2012 January. The head developed in 2012 July. The right shoulder developed in 2012 November. The neckline of the pattern connects the 2012 March low and the 2012 September low. The value of the neckline is currently near support near $0.795.

(Read More: Euro Rally to Test $1.40 Soon: Charts)

The head and shoulder pattern is invalidated by a sustained rally and move above $0.815. The upper point of the right shoulder is also a well-established resistance level. The right shoulder pattern could continue for several weeks as part of a sideways consolidation movement between $0.795 and $0.815. This extended sideways movement does not invalidate the head and shoulder pattern.

The head and shoulder pattern is confirmed with a sustained move below support near $0.795. This level provided both support and resistance in 2011 and 2012. A fall below this level has a downside target near $0.745. This target is calculated by measuring the distance between the neckline of the head and shoulder pattern and the top of the pattern.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com . He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

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