Except for a small blip in the euro, the forex market is unusually calm, considering the storm of volatility that is gathering on the horizon. Brokers are already warning that margin requirements will be adjusted upwards for the foreseeable future, until the expected wave of craziness passes through.
Why the concern? The following week includes a number of PMI releases, four central bank meetings, another crucial Non-Farm Payroll report prior to a major Fed meeting, and then the party will be capped off by the U.S. presidential election returns on next Tuesday night and early Wednesday morning. If you think the Brexit referendum was a fun ride, then prepare for a similar ride on steroids.
The wires are alive with every forex pundit pontificating that he knows where the most opportunity for gain is hiding. Will the euro continue upwards, or is now the time to short and run? Will the loonie jump for joy with oil prices or will it dive for cover? Has the yen finally settled down for a long winter’s night or will it strengthen once again? Will the pound sterling come out of its doldrums or slide more in the southerly direction? Stay tuned, because this train is moving down the track and may not stop for the station.
How is the USD Index currently positioned for the ride to come?
Here is the latest USD Index information for CY 2016. The theme for this pattern has been the market’s way of losing and then regaining confidence in the Fed and its attempts at interest rate normalization. Last December, the Fed was beaming after finally adjusting its benchmark rate by a whopping 25 basis points and proclaiming to the world that four more adjustments would be on tap for the forthcoming year. Not! The global economy fell apart at even the thought that cheap money would be withdrawn. The Fed pulled back. The dollar fell like a rock, but, like Sisyphus of Greek lore, market forces began pushing the rock back up the hill in anticipation of another December hike.
After ranging for four months, the USD kicked into gear in October, once the September FOMC confab confirmed that no rate hikes would be considered until after the election. The probability of a December hike began to soar in the futures markets (now at 70% to 75%) and lifted the greenback back near “100” territory. It has softened a bit, hovering now around 98.4 and waiting for election results to determine its future direction. It appears overbought at this point, but the slope of the Slow Stochastic indicator suggests that upward momentum is still in the cards. If King Dollar pushes past the 100 level, then other major pairings must also weaken.
Market drivers in order: Jobs report, Politics, and the Fed’s December meeting
These three drivers will overshadow any economic news releases over the next two weeks or so, but the November unemployment report may only cause a subdued ripple, due in part to the significance of the latter two items. Another reason is that the market hardly noticed a 2.9% jump in GDP growth in the third quarter. A positive jobs report may receive a similar ho-hum.
On the political front, the end is finally in sight. As in most elections, the polls have drawn closer and closer, refusing to divulge a massive reaction that could occur. Will populist angst over immigration and economic equity drive home the vote for Donald Trump, as it did in the Brexit referendum? Will the voting public opt for a more traditional approach to making change in government by siding with Hillary Clinton?
The political press is having a field day debating both of these questions. Depending on the chosen commentators, you may hear bombastic rhetoric that adamantly boasts of the correctness of its forecast, or a more subtle discussion of facts that support its opposing prognostications. One thing was clear from Brexit. It is very difficult to predict how emotions might turn a voter’s opinion when his final ballot is cast.
In the UK, the populist insurgency at hand was strong and clearly underestimated by pollsters and opposing forces. Due to this phenomenon, one can sense that markets are preparing for a potential surprise, judging from the choppy behavior of late.
Clinton’s lead had been in the double digits a week ago. Discussions quickly moved to down ballot races and the prospect that a Clinton landslide could move Congress back into the hands of the Democrats. The press, however, loves controversy. After all, it improves ratings. Over night, coverage switched almost completely to Trump’s dilemma. How could he and his supporters possibly shift momentum back in their favor? For whatever reason, polls began tightening. The Mexican peso and the Canadian dollar began to slide. The euro and yen improved. The pound remained flat, but the Aussie found solace in better manufacturing data from mainland China.
What is on tap for another round of central bank meetings?
Diversification in central banking monetary policy is still the name of the game. The Fed and central banks in the UK, Japan, and Australia have meetings this week, but Europe and Canada will not be quiet from an economic release perspective. No substantive actions are expected at any of these meetings, although rumors are active that the BOE and the RBA might reluctantly reduce rates a tad.
These prevailing rumors, however, have not materially affected valuations in the futures markets, a sign that neither is of any substantial consequence. Another rumor making the rounds is that Carney might step down from his post at the BOE. Criticism has been broad based, but investors would not look kindly on his departure. The pound would suffer.
What are the short-term prospects for major pairings with the USD?
The latest thinking for short-term movements for each major pairing follows:
EUR/USD: The euro recently shot up to 1.105, thus penetrating a prominent resistance/support level at 1.10. Will the momentum continue? Most analysts think not. They see the current position as unsustainable, regardless of Trump’s rebound in the polls or regional economic data that has been trending in the right direction. As long as Brexit remains in the “on” position, so goes the pound, so goes the euro, according to the experts.
Many forex departments in banks are wagering that 1.05, after 1.11, is the next logical destination, thereby suggesting that it is time to go short. As long as Trump is defeated, this strategy seems supported by current evidence, but the “herd” is often wrong. Its recent move upward appears very strong, but another day will tell.
GBP/USD: Of these five pairings, the pound has been trapped in the tightest range of all of late. After its fall from grace following the Brexit referendum, sterling settled in at 1.32, but has recently fallen to 1.22. Is parity with the greenback really in the cards? The recent fall came after Parliament resumed, and the new government reiterated its determination to follow through with exercising Article 50 in early 2017.
Analysts are beginning to believe that the market may have over reacted to September’s rhetoric. The UK economy is behaving nicely. There has been some talk of a rate cut, but there are no takers at the moment. A period of upward consolidation may be in order.
USD/JPY: The BOJ has retained its accommodating stance, striving to drive inflation up to targeted territory, and the yen has weakened accordingly over the last month. The resurgence of Trump-ism in recent polls, however, created a mad rush for safe havens in the last few days, strengthening the irrepressible yen by more than 100 pips. Will the BOJ keep expanding the money supply or begin tapering? Many believe that recent actions support the latter, which could forebode a stronger yen in the near term.
AUD/USD: After the Brexit referendum, the Aussie has been stuck in neutral, ranging within its 74.5 to 77.0 support and resistance boundaries. It has responded positively to improving manufacturing data in China and anything that resembles support for Trump in the press. The 77.0 threshold has been formidable, especially when the prevailing rumor is that the RBA will reduce interest rates. The need for a rate cut may be fading, as commodities make a comeback. Further improvements in China and better trade arrangements can only boost the currency from down under.
USD/CAD: So goes oil, so goes the Loonie, or so they say. The travails of oil prices have been a never-ending storyline for 2016. The Canadian dollar hit 1.25 versus the USD in May, but it has been on an inexorable decline since that zenith and is now hovering about 1.34. Momentum indicators suggest that the Loonie might regain some ground in the near term, but the probability of an OPEC cut in production grows weaker with each passing day. The Canadian economy is not keeping pace with its southern brother, which may also weigh heavy on the Loonie. Current thinking is that things could get worse, perhaps 1.36, before getting better.
Will King Dollar move above the “100” index watermark? Yellen could always back off a December rate hike. Trump could win, and conventional wisdom presumes the USD would fall, since trade relations going forward would be uncertain. In today’s economic reality, if America is to be great again, as Trump supporters proclaim, then it would have to be at someone else’s expense. The consequence may be a reordering of international trade to the detriment of the United States. On the other hand, if Clinton wins, the USD could soar, creating another currency crisis, as dollar-denominated debt across the globe expanded in value and default risk. Under these circumstances, the Fed would likely defer a rate hike in December.
Concluding Remarks
The next ten days will certainly roil our financial markets to a seething boil, which could erupt even further if populist fervor prevails in the U.S. presidential election. If this event were the only thing on our agenda, then we might have a clearer picture of how things might play out, but it is not. A host of economic and job data releases, along with central bank maneuvering, will keep things jumping with anticipation.
There is always a portion of the trading community that loves to speculate beforehand. This type of positioning tactic often creates opportunities before the deciding event, which can lead to “sell-on-the-news” behavior down the road. Algo-trading robots will also attempt to arbitrage each swing in market action, keeping things moving in every direction. Volatility will rule. Our advice – stay cautious and prepared!
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.