The US dollar surged at the end of the week, helped by a hawkish statement by a perceived dove at the Federal Reserve and dramatic drop in the Turkish lira, which spurred a broader rout in emerging markets and risk assets in general. We remain bullish the dollar, based primarily on the US policy mix and the divergence in interest rates. 

However, we suspect that the short-term market is exaggerating the systemic threat posed by Turkey. The low credit quality, the simply terrible macroeconomic backdrop, policies that repel investors, and the erosion of the central bank’s independence mean that exposure by global funds already had been reduced. European bank write-downs and write-offs appear manageable. The indirect impact could aggravate situations that are already fragile, like the periphery of Europe.  

The dollar’s surge has left it over-extended. The Dollar Index closed above 96.05, the 50% retracement of last year’s sell-off, but also well above the upper Bollinger Band (~95.80). In fact, all the major foreign currencies, save the yen and Canadian dollar finished outside their respective Bollinger Bands. It would be not unusual for the Dollar Index to return to the breakout, which we peg in the 95.50-95.60 area. On the upside, the next retracement target is found a little below 98.00.  

The euro’s lower Bollinger Band is seen near $1.1485. It is the first time since late May that the euro closed below it and then proceeded to rally almost 3.5 cents. The $1.1450 area corresponded to the 50% retracement of last year’s rally. The 6.18% retracement is seen a little below $1.1200. A break there would lend more credence to our conviction that last year’s dollar sell-off was, from a technical perspective, corrective in nature. In the bigger picture, the euro may have broken below the neckline on a head and shoulders pattern on the weekly bar charts. (~$1.1460), which has a measuring objective of around $1.05.