USD On Fire, But Is The Rally Justifiable?

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 |  Includes: UDN, UUP
by: FXstreet

It was all about the US Dollar on Wednesday, displaying an outstanding performance as speculators got busy pricing out increased chances of a sooner-than-expected end/tapering from the Fed's quantitative easing program.

The US FOMC Minutes from the January meeting opened a dangerous can of worms, signaling that 'several' members called for a possible downward revision to the amount of bond purchases by the Fed, indicating that "the Fed should be prepared to vary the pace of its $85bn/month QE program."

While there is still a widespread debate over the United States economy being able to pick up enough momentum, so that the Fed can end asset purchases towards the end of 2013/early 2014 - we need a significant improvement in the jobs sector -, what the charts are telling us is something to take notice of.

As Nomura economists note: "The chances of ending/tapering asset purchases before the outlook for the labor market improves substantially has risen materially" the bank said.

A valid point to make after the wild reaction in favour of the US Dollar, is that, there seems to be a sense of confusion up in the air, with the market behaviour transmitting over-confidence over an imminent threat of 'QE to infinity' getting an expiry date.

Did the market get ahead of itself? As Forexlive editor Eamonn Sheridan reminds us, "it was only December when we got the 6.5% unemployment / 2.5% inflation guideposts from the Fed." He asks, are they going to change so soon?, replying that "recent speeches from Bernanke and Yellen would suggest not", yet it is undeniable that the big moves in the market are communicating a change in perspective. Whether it will develop further legs or not, time will tell.

Sebastien Galy, currency strategist at Societe Generale, notes the markets are going through a phase of instability and are badly positioned structurally for having to deal with a potential more hawkish Fed, thus the USD heavy buying.

Mr. Galy notes: "The reaction has been most severe on the liquidity fuelled equities and the short USD position. We have been talking for a while about the degree of instability in FX and it is increasingly showing." This instability, as Sebastien notes, "has not yet hit the core European Union-related assets vs US Dollar in full force, yet the odds are increasing, he says.

According to Kathy Lien, co-founder at BKAssetManagement,

If the Fed Chairman confirms that asset purchases are being reviewed, today's rally could become a real turnaround in the U.S. dollar; if he downplays the possibility and suggests that these are very initial discussions, the dollar could give back its gains quickly.

On the EUR/USD domain, in view of Fan Yang, chief technical analyst at FXTimes:

It is now pressuring toward the 1.3255 support of a previous consolidation in January, but more importantly a rising trendline that goes back to the July low where the current bull trend started. Breaking below 1.3150-1.3170 area might be needed to clear support factors and confirm a reversal into a bearish trend. A pullback should not push above 1.3350 if the bearish outlook is to sustain.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.