Dollar Poised for Gains as Fed Starts Tapering
Forex markets had an unexpected pickup in volatility last week, as the US Federal Reserve announced its intention to begin cutting back on stimulus programs. The end result for currency traders was a broadly higher US Dollar, which started to regain some lost ground against the recently surging Euro and British Pound. Overall, the trimming back in quantitative easing stimulus is positive for the Dollar because this essentially means there are fewer Dollars running through the system. Decreased supply and steady demand means an increase in prices, and this basic rule of economics applies to currency markets as well.
And when we take these developments in conjunction with the fact that the other major economies are still in comparatively early stages in their own quantitative easing programs, with no immediate signs of slowing. The Eurozone has recently reduced interest rates to new all time lows, the Reserve Bank of Australia is now on course to lose its position as the country with the highest yielding currency, and Japan has made no mention of any needs for changing its own monetary policy. From a long term standpoint, taking all of these stances in comparative combination, there is little that could reasonably prevent the US Dollar from gaining well into the first quarter of next year.
The Week Ahead in Forex Markets
Now that we have seen the Federal Reserve commit to an exit strategy, markets will likely start to focus more closely on macro data releases and the central bank commentary of other countries. In the week ahead in forex markets, we are likely to see a slowdown in market volatility now that we are heading into the final sessions of the year. These types of environments lend themselves best to strategies that are focused on trading ranges rather than breakouts. As such, we should not expect any significant changes in the coming week. This does not, however, mean that no money can be made during these sessions. Range trading strategies often prove to be highly profitable under these conditions, as there is a reduced chance that protective stop losses will be hit when placed outside of the day’s price range.
Given the events of last week, it makes the most sense to begin establishing limited long positions in the US Dollar, as there is likely to be some hangover effects from the Federal Reserve in next week’s trading. Since market liquidity is currently reduced, not as many traders have had the opportunity to react to the Fed’s stimulus decision. This means that there is still some Dollar buying that has not yet occurred. Overall, expect a slightly upward bias in the Dollar, as peripheral currencies like the British Pound start to show evidence of weakness. Ultimately, these are themes that should continue well into the first quarter of next year, albeit to a lesser extent.