Dollar extends declines but down days could be numbered

After yesterday's sharp declines, the U.S. dollar fell further against her Asian counterparts and the slump continued in early European session with the British Pound/U.S. dollar (GBP/USD) currency pair surging north of 1.3150. The dollar fell most notably against the Japanese yen, which rallied across the board. Investors piled in on the yen due to its perceived safe haven appeal as they feared North Korea tensions may rise again at the weekend in the event of another missile launch. News that South Korea has detected xenon, possibly from North Korea nuclear test sent the U.S. dollar/Japanese yen (USD/JPY) currency pair below 107.50.

The U.S. dollar has been out of favor throughout this year as investors continually had to price out the prospects of an aggressive rate hiking cycle from the Federal Reserve, owing to deteriorating U.S. data and political turmoil in Washington as doubts rise over Trump administration’s ability to deliver stronger growth. The depreciation of the dollar helped to underpin a number of major currency pairs as well as gold, silver and other buck-denominated metals. U.S. equities also benefitted from a weaker currency, while the stronger the euro/U.S. dollar (EUR/USD) currency pair exchange rate helped to keep the gains for European shares in check.

Could dollar make a surprise comeback?
However, with sentiment being so bearish on the dollar, I can't help but think we could see a nasty short squeeze rally in the coming days or weeks. Any sudden improvement in data could see investors pile back into the oversold dollar. But we are still waiting for a stimulus to arrive in order to trigger a dollar rally. Until we see that stimulus and a corresponding sharp rally in the dollar, or a major technical reversal pattern, we remain bearish on the greenback, but to a lesser degree because most of the negativity may be priced in by now. Indeed one could argue, the selling may be overdone.

USD/CHF on watch for potential dollar comeback
With that in mind, we are on the lookout for signs of a dollar comeback, especially against currencies where the central bank is still dovish. A good example is the Swiss franc with the Swiss National Bank still charging negative interest rates and threatening to loosen its monetary policy further if needed, not to mention its ongoing intervention in the FX markets. The U.S. dollar/Swiss franc (USD/CHF) currency pair, therefore, could be among the first dollar pairs to show potential strength when the dollar starts to comeback. On that note, the Swissy has again refused to hold below the 2016 low of 0.94445 after a brief dip below it earlier this morning.  This could be a potential turning point as it clearly shows the sellers are unwilling to offer the pair below this level. So far however, we haven’t had a clear break in market structure to suggest the downtrend is over. Once we create a higher high then this would confirm a bullish reversal. For now though, we treat this as a mere short-covering bounce and will continue to watch short-term resistance levels closely as price could still head further lower. Specifically, a couple of the key short-term resistance levels to watch include 1.9495 and 1.9530. Any potential move above 0.9590 would be bullish in the short-term. On the downside, if the USD/CHF breaks and holds below 0.9445 then the Fibonacci extension levels at 0.9360 (127.2%) and 0.9245 (161.8%) would be the next bearish objectives.