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Author: Seeking Alpha
As the G20 concludes and the U.S. equity markets decline, the U.S.
dollar is playing pivotal role in both the foreign currency markets and
geo-political posturing. Last fall, during the height of the economic
crisis the U.S. dollar index broke a 6 year downtrend which began in 2002. As the dollar peaked in March 2009, the U.S. equity markets began to find firmer footing and the year long relationship between the dollar and equities blossomed. U.S. Dollar Index (Cash) – Monthly Chart (Click to enlarge)
Over
the last 6 months the U.S. dollar index has declined in what may turn
out to be a correction. Furthermore, over the last 6 months both the
implied volatility and historic volatility have been cut in half from
above 20% to below 10%. Implied Volatility and Historic Volatility on U.S. Dollar Index Futures Options (Click to enlarge) 
We
also note that since the beginning of September the implied volatility
index has climbed substantially above the historic volatility. The
implication is option traders have been expecting a big move in the
dollar index. While implied volatility tells us what the market
is expecting it does not tell us the direction of the expected
volatility. In the U.S. dollar index, the implied volatility on
both the puts and the calls have been rising in tandem, which means
they offer little information for directional analysis. Combining
the technical and volatility analysis we deduce the likelihood of a
dollar reversal has increased significantly. Adding the weakness in the
U.S. equity markets fortifies our conclusion. Just as the weak
dollar fueled the rise in the equity markets it is possible that the
strong dollar fuels a decline. The two markets can form a
vicious circle that mirrors the action we have seen over the last 6
months. The stronger the dollar gets the weaker the equity markets
become, this weakness in turn causes a flight to safety and the dollar
becomes stronger.
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