US Dollar Higher as Profit-Taking Ensues
In the forex markets, one of the most pronounced trends of the last few months has been the sell-off in the US Dollar. These bearish moves have been driven largely by the market re-adjustment to the expectation at the Federal Reserve that tapering programs will continue.A majority of the market now sees no change in quantitative easing stimulus until the end of Q1 2014, which is now quite a ways off. Since we will not see fewer Dollars available in the market, supply and demand dynamics would suggest that the Dollar should continue to weaken unless we see some reason to believe that the Fed will start to make reductions in its $85 billion in monthly purchases of Treasuries and mortgage backed securities. Longer term, the results have been as expected: a lower US Dollar.
But it should be remembered that forex markets are driven by sentiment and trade positioning. Those short on the Dollar will want to take profits on those positions at some stage. Once a short position is closed, it effectively becomes a long position and this helped push the Dollar higher into the end of last month. The Euro in particular saw some of the most significant weakness, with the EUR/USD now trading firmly below the critically important 1.35 psychological level. If we remember back to when this year saw its first topside break of this level, it was clear that investors had drawn a line in the sand. This propelled prices higher and pushed prices to a surge that looked as though it would actually test 1.40. The next question going forward is whether or not the same type of event will happen on the downside, now that Dollar strength has sent prices back through 1.35 once again.
The Week Ahead in Forex Markets
Looking ahead to next week, a large section of the market’s attention will be centered on the next monetary policy meeting at the European Central Bank (ECB). Recent weakness in the Euro could be viewed as a problem as the surprise in volatility jars export markets and the ability of Eurozone residents to make purchases abroad. The ECB is unlikely to give the markets any reason to continue with the downside volatility in the Euro, so this essentially means that mentions of additional monetary stimulus will probably not be seen.
This would be a positive for the Euro but a negative for Eurozone equity markets (such as DAX, CAC, or IBEX) and it will be important for forex traders to position accordingly after the meeting reaches its conclusion. In addition to this, we will need to watch economic data of the US, as this will provide additional clues as to whether or not the Fed will be forced to hold stimulus programs at their current levels. Any evidence of additional stimulus would be a negative for the US currency.