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Risk Sentiment to Control Underlying Tone

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March 10, 2014 By: , No Comments

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Forex markets got off to a slow start in the early sessions last week as traders held off on committing to positions ahead of several key event risks.  Market sentiment is currently being governed by a few different factors, as political conflicts in the Ukraine are being taken alongside the potential for shifts in central bank policy initiatives.  Catalysts for these policy changes will depend on macro data but we had some important developments last week in that area as well.

Last week’s ECB meeting showed that there is less flexibility to ease policy or inject new monetary stimulus given the fact that consumer inflation levels are expected to start rising.  Higher interest rates create a bullish scenario for a currency because this means that investors have more incentive to hold long term buy positions.  If we continue to see comments from the ECB which show concern for potential inflation increases, we can expect to see further gains in the Euro over and above the 1.40 mark (in the EUR/USD).

We can expect divergences in central bank policy to start to take more of the market’s focus in the next few months as there will be some important policy decisions that will need to be made in various regions around the world.  Specifically, this means the European Central Bank and the US Federal Reserve.  But there will be other areas to watch as well.  Key examples also include the Bank of England and the Swiss National Bank.

The Week Ahead in Forex Markets:  Employment Data Supports Bullish Outlook

In the week ahead, we need to watch for the ways forex traders continue to react to the employment figures released last week.  The numbers did come in above market expectations.  The final result showed an increase of 175,000 jobs for the month of February.  This was a big positive because the January figures were abnormally weak and the ADP precursor data was less than expected.  Initial estimates were calling for an increase of 155,000 jobs so these figures should being some buying back into the US Dollar after its recent bout of weakness.

We are still seeing some highly overbought currency pairs in the forex markets, so there is some potential for reversals — if not next week, then probably before the end of this month.  One of the better examples here is the GBP/USD, which has seen a significant fun higher in the last few months and remains vulnerable to any policy swings that might be shown by the Bank of England.  Shorter-term, markets will likely react favorable to the employment data seen last week as this largely confirms that the global recovery is still alive and well.  This should calm some of the selling in the greenback and make it easier for forex traders to start building positions in high yielding currencies.

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