Euro Strengthens as Alternatives Remain Limited
Forex markets were slow in the early parts of the week, as there was little reason for traders to commit to new positions ahead of the all important Fed release on Wednesday. Forex markets looked to this release to assess the general policy bias of the majority of voting members at the Federal Reserve. Upbeat assessments of the economy (specifically, in labor markets) are likely to generaterenewed speculation that the central bank no longer finds it necessary to add monetary stimulus at the same asset purchase rate.
But the report as a whole only moderately shifted investor focus toward these expectations, as the general effect was to indicate that the Fed is willing to begin cutting back on stimulus. Forex traders were looking for a more specific timeline describing when this will occur, but there was no mention of this in the report. This essentially adds to market uncertainty and places a higher level of importance on new Fed comments in the coming weeks.
Immediately after the report, the Dollar did see gains as decreasing money supply would be bullish for the currency longer term. This outcome is even more valid, given the fact that most of the other major central banks (specifically, the European Central Bank and the Bank of Japan) are still in the middle phases of their own stimulus programs. Overall, this points to a bullish outlook for the Dollar on a comparative basis for those positioning themselves on a longer term time horizon.
The Week Ahead in Forex
Into next week (and well into next month), price activity in the major currency pairs will be governed by the changing Fed expectations that will likely push and pull market sentiment going forward. When we look at recent trends, most of the evidence has supported the Euro, and put major downside pressure on the Japanese Yen. So far, the Dollar has been the “middle player” in this equation, but this is unlikely to last much longer given the increased volatility that is likely to come before and after actual changes in policy.
As far as data is concerned, the next Non Farm Payrolls number is going to be even more critical than usual, because the Fed is looking at the unemployment rate as the central indicator for the strength of weakness of the US economy. Currently, this number is holding at 7.4%, which is the lowest number in four years. For forex traders, any further declines should help make a strong bullish case for the US Dollar, as there is little reason to believe the Fed will be able to isolate areas of concern for the economy. This would make reductions in quantitative easing stimulus a near certainty, and initiate a fresh bull wave in the Dollar, especially against the Euro. Any stagnation in this economic data, however, could have the opposite effect, as the July minutes ultimately suggest a “before the end of the year” timeline, rather than a specific policy change in September.