Dollar Under Pressure in Thin Markets
Forex markets have shown little reaction to the recent decision by the US Federal Reserve to begin reducing quantitative easing stimulus (with its “tapering” exit strategy). In terms of general rules for the forex markets, it would make sense for the US Dollar to see a surge in strength when plans like this are announced. This is largely because reduced stimulus packages from the Fed will mean that fewer monetary injections are made into the economy. Fewer Dollars in the system indicates a decrease in supply and this is generally positive for market valuations.
But the US Dollar has held largely under pressure against nearly all of its major counterparts (with the exception of the Japanese Yen). It can be argued that the market has mostly ignored the Fed decision and sold the Dollar because tapering was seen as an inevitability and was expected by most currency traders. The result has been drifting weakness in the greenback in holiday thinned market liquidity. How long these moves can continue, however, still remains to be seen. We will need to see some significant improvements in the underlying economic fundamentals found in areas like the UK and the Eurozone.
At the moment, broader GDP growth in these two areas remains below what is seen in the US, so many traders have started to argue that the recent weakness in the US Dollar represents a long term buying opportunity more than anything else.
The Week Ahead in Forex Markets
In the week ahead, forex traders could very well see some choppy price activity as market strength remains below normal levels. With the New Year holiday leading to exchange closures in several key regions, we will likely see more of a reluctance for traders to commit to large forex positions. This, of course, does not mean that market activity will slow to a standstill, so there are still opportunities for traders to make gains on their positions.
From a strategy perspective, it makes sense to look at currency pairs that offer some carry value and this could begin to favor the currencies that are associated with elevated interest rates. This is another scenario that does not bode well for bullish reversals in the US Dollar. But most of the real rallying could easily center on the Yen-denominated pairs (like the AUD/JPY, GBP/JPY, and USD/JPY). We have already seen some large moves in a number of the pairs that fall into this category. But with the slower than normal trading conditions in place, the potential risk for loss at these elevated levels should not be drastic.
In any case, it makes sense to take gains relatively quickly once positions turn positive, because we will likely see a big slowdown in momentum when the holiday sessions finally roll around. We could start to see activity start to pick into Thursday and Friday, however, as traders start flowing back into the markets.