Dollar Sentiment Hinges on US Congress Debates
Forex markets continue to show the expected increase in volatility that typically accompanies the post-Summer trading period. But this year, the activity has been even more extreme, as a series of long term event risks have yet to resolve themselves. First, we still have divided markets in terms of Federal Reserve viewpoints. Will the US central bank start to taper its stimulus programs, or hold off until the broader economy shows better signs of progress? Recent declines in the US Dollar have been propelled by decisions to leave stimulus programs on hold, which is an implicit suggestion that the Fed is not convinced that improvements in economic data are sustainable.
If this was not enough of a negative for the US currency, we now have the much publicized budget impasse, which continues to add pressure to the greenback. Further stalling could potentially lead to defaults in federal credit agreements — and this would likely generate downgrades from multiple ratings agencies if this possibility became a reality. Toward the end of the week, we did start to see some upside moves in the Dollar — as the Euro, British Pound, and Japanese Yen all posted negative closes on Friday. But in order for these moves to continue, we will need to see this speculation turn into action. Without this, the Dollar is vulnerable to further declines into the end of October.
The Week Ahead in Forex Markets
Looking ahead to next week, most of the attention will remain centered on the budget debates in the US. Economic data has been largely disregarded recently, as important releases in the UK and Eurozone have been mostly ignored. Additionally, the Bank of Japan had some important results at its last policy meeting (deciding not to increase purchases in its stimulus programs). But next week will be largely devoid of macro releases that are likely to move markets and this hole in the economic schedule will leave investors with little else on which to base trading decisions.
For forex traders looking to establish long term positions, this latest bout of Dollar weakness presents some interesting opportunities to get long again in pairs like the USD/JPY or USD/CHF. This, of course equates to short positions in pairs like the GBP/USD or EUR/USD. But with all of the latest moves starting to look over extended, traders should start to consider longer term time horizons. For those with shorter term styles, market activity is likely to be more erratic and unpredictable, at least until the US government shutdown resolves itself. Because of this, these types of positions are more risky and not exactly ideal for the current trading environment. Overall, trading activity during the month of October should continue to be choppy, as there is little concrete evidence to support the primary direction of the next major trend in forex markets. Those that are trading should consider smaller positions sizes, which are better able to absorb short term volatility.