Dollar Shares ($UUP) Repercussions on Future Volatility

Stock market averages are modestly lower midday Tuesday after achieving record highs the day before. The S&P 500 is down 7.45 points to 2182.63 and two points from session lows.

Treasury bonds are seeing modest weakness on in-line inflation (CPI) data and after New York Fed President Dudley signaled a more hawkish view on Fox Business News Tuesday morning. Better-than-expected readings on Industrial Production and Housing Starts added to the selling pressure in the Treasury market and the yield on the benchmark ten-year ticked up to 1.58%.

Mostly quiet trading in the commodities market, as crude oil added 31 cents to $456.05 and gold gained $5.5 to $1353.

On Wall Street, eight of ten market sectors are lower, led by losses in Telecomm (IYZ), Utilities (XLU), and Healthcare (XLV). Basic Materials (XLB) and Energy (XLE) are seeing modest gains.

On the options front, CBOE Volatility Index (VIX) is up .48 to 12.29 and volumes remain light as many desks are operating with skeleton crews during the vacation season. Roughly 3.1 million calls and 2.7 million puts traded through the first two hours. Projected volume for the day is 13.8 million and 3% below the one-month daily average.

Meanwhile, the US dollar is in the spotlight Tuesday as it suffers notable losses against other major currencies Tuesday. The chart below shows the performance of the PowerShares US Bullish Dollar ETF since January. Trading under the ticker symbol UUP, the fund tracks the performance of the buck against a basket of other majors. However, it is heavily-weighted toward the euro/USD currency pair.

See Tradespoon’s Stock Forecast on POWERSHS DB US DOLLAR INDEX-DOLL INDX BULL (UUP)

Tradespoon’s Stock Forecast on POWERSHS DB US DOLLAR INDEX-DOLL INDX BULL (UUP)

As we can see, today’s slide in the dollar has led to a decisive move below the 50-day moving average and to one-month lows for the Bullish Dollar Fund. While the weaker dollar is not necessarily a negative for corporate profits (and is, in fact a positive for multi-nationals), it is being viewed as a negative in the current environment due to the implications for future volatility. Namely, strength in currencies used to fund the carry trade can result in increased gyrations in currency markets as positions are unwound and that volatility can spill over into other assets, including equities and bonds.

For that reason, perhaps, the S&P 500 is drifting off its record highs Tuesday, even as bonds and the dollar move lower as well. $24.50 is a support level to watch on the Bullish Dollar fund, as well as $24.30 and June lows near $24.15. On the upside, look for resistance at $24.60, $24.70 and the 50-day moving average.

The S&P 500 has resistance at yesterday’s intraday and closing record highs of 2190 and 2194. Short-term support likely at 2181, 2175, and 2161.