USD Price Outlook: US Dollar Sinks as Euro Rallies to 1.2300

US DOLLAR OUTLOOK: EUR/USD EXTENDS ADVANCE TO PROBE 1.2300-PRICE LEVEL

• USD price action took a tumble during Wednesday’s trading session to fresh yearly lows
• US Dollar weakness was broad with notable declines against the Euro, Pound, and Aussie
• DXY Index might gravitate lower into the New Year as EUR/USD eclipses the 1.2300-level

The US Dollar stumbled -0.41% lower on Wednesday as selling pressure reaccelerates into year-end. A prolonged period of US Dollar weakness since its mid-March peak sets the DXY Index on pace for a -7.2% annual decline. This follows a recent acceleration in US Dollar downside largely fueled by EUR/USD price action. In fact, with the Euro extending its rally to 640-pips over the last two-months, spot EUR/USD was able to pierce the 1.2300-price mark for the first time since April 2018.

DXY – US DOLLAR INDEX PRICE CHART: DAILY TIME FRAME (MAR 2019 TO DEC 2020)

Chart by @RichDvorakFX created using TradingView

Seeing that the Euro is the largest component of the DXY Index with a 57.6% weight, it is unsurprising that the US Dollar generally mirrors the direction of EUR/USD price action. Correspondingly, if Euro strength is sustained against its US Dollar peer, the DXY Index will likely remain under pressure. This brings into focus potential for jawboning comments from ECB officials who might attempt to talk down the Euro at these levels, however.

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Nevertheless, it is important to note that the latest stretch of US Dollar weakness remains broad and is a theme that looks likely to continue so long as the Federal Reserve stays uber-accommodative and keeps market sentiment buoyant. To that end, AUD/USD and GBP/USD were the best performing major currency pairs on the session after notching rallies to the tune of about 80-pips and 120-pips respectively. This propelled the Aussie and Sterling to fresh yearly highs against the Greenback.

USD PRICE OUTLOOK – US DOLLAR IMPLIED VOLATILITY TRADING RANGES (1-WEEK)

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That said, the US Dollar might catch a relief bounce if potential catalysts for volatility materialize. One-week US Dollar implied volatility readings have started heating up as they now encompass 06 January 2021, which is the day congress is scheduled to receive official election results transmitted by states. Though a smooth transition of power is widely expected, any given rise in uncertainty could prompt a serious risk-off move. Likewise, potential for a gloomy rise in covid numbers due to the holidays may raise the threat of more lockdowns and dwarf vaccine optimism. Either of these scenarios, if materialized, would likely result in an increase in demand for safe-haven currencies and drive a bid beneath the US Dollar.

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— Written by Rich Dvorak, Analyst for DailyFX.com

Connect with @RichDvorakFX on Twitter for real-time market insight