It has been a week since the Federal Reserve surprised the globe when it backed off from its earlier tough talk about bond tapering. The U.S. dollar index (UUP) plunged in response but it has yet to follow-through on that selling:
The U.S. dollar index plunges post-Fed but is still hovering above the lower part of a wide trading range
This was a case where the market seems to have guessed correctly about the likelihood of tapering. The U.S. dollar index sold off for two weeks going into the meeting as expectations for tapering dropped from ending the entire program in one big gulp to a $10B shave and nibble. St. Louis Fed President James Bullard noted in a Bloomberg TV interview that the difference between a $10B taper and doing nothing is probably negligible. I agree in terms of impact on the real economy, but the response in financial markets demonstrated that "do nothing" is considered materially different than "do something." Regardless, the U.S. dollar index has not seen current levels since February. It remains above its "QE3 reference price" - its level right before the Fed announced QE3.
I am still bullish in the short/intermediate-term for the U.S. dollar. I expect that in due time the U.S. dollar index will trade back to the top of the current range. However, as I searched and reached for reasons to continue justifying this stance, it occurred to me that the forex market in general has been surprisingly listless since the Fed meeting compared to the immediate post-Fed response. It as if it markets are coiling in preparation for the next big move. It is hard to tell whether the forex markets will treat a U.S. budgetary impasse as dollar-good (a "safe haven") or dollar-bad (relative downgrade in economic prospects). At times like these, I like to remove my chips and watch, listen, and learn.
Here are the biases I currently maintain as I wait for the next trade-worthy entry points and/or catalysts.
British pound (FXB)
Recent economic data from the UK and the last Inflation Report have strongly validated my stubborn bullishness on the British pound. For September, the pound has essentially been the currency of choice as it has beaten up on all the majors except the Swiss franc (FXF). The pound has raced particularly sharply against the U.S. dollar with very little pause or rest. It took the post-Fed surge to finally exhaust some buying power. The pound is now retracing its post-Fed steps. The upcoming GDP report could set the tone for the next phase of trading. I will continue to look for reasons to be bullish and to buy the dips.
The pound has raced against the dollar this month
(Note that the diagonal line in the upper right corner is the presumed post-recession downtrend that connects back to GBP/USD's post-recession high set all the way back in August, 2009).
The euro is reaching its high for the year against the U.S. dollar, and I simply cannot imagine it getting much higher. I remain bearish against the euro and think that it is only a matter of time before the market starts caring about economic under-performance. For now, the euro is a beneficiary of bets against the U.S. dollar as it is the largest component of the dollar index. Of course, if the eurozone begins to produce notably weaker economic data, it may start to undermine my bullishness on the pound. I will take this one step at a time.
On Monday (September 23), Mario Draghi, President of the European Central Bank (ECB), appeared before the European Parliament. Draghi talked both about his readiness to execute another long-term financing operation (LTRO) to fight rising interest rates (resulting from a reduction in liquidity in the banking system) AND about his sensitivity to the risks of keeping rates too low for too long. This kind of "lean both ways" messaging makes it difficult (for me) to form a strong short-term trading bias. So, I am going with my longer-term bias and inserting it into my shorter-term view.
The euro is reaching its high for the year against the U.S. dollar
The Canadian dollar (FXC)
I remain bearish on the Canadian dollar for both the short and longer-term. The Canadian dollar was one of the first currencies to completely reverse its post-Fed gains against the U.S. dollar. I think this behavior is a sign of further weakness to come. I would like to start buying USD/CAD again at current levels.
Last Friday, Canada reported a series of economic data points that all met "expectations." Inflation remains low, and there remains no reason for Canada's central bank to raise rates again anytime soon.
The U.S. dollar has trended upward against the Canadian dollar for a year with wild swings in between retests of the trendline
Japanese yen (FXY)
The yen was the other major currency to quickly reverse its post-Fed gains. That fade is currently getting faded (the fade of the fade). Overall, I still think the plan laid out by the Bank of Japan in April is "enough said." I still find the BoJ's "monetary psychology" particularly compelling and telling. Outside of the occasional panic button that traders hit to send the yen pulsating with new life, I see no reason to change my bearish stance on the yen anytime soon. My bias makes me believe that the overall stalemate in USD/JPY since April will get resolved to the upside in due time. From a technical standpoint, that time COULD be coming soon as the 50 and 200-day moving averages (DMAs) slowly converge.
As the oscillations in USD/JPY decline, it seems a breakout (or down?) looms close by
Of course, this stalemate between the U.S. dollar and the Japanese yen translates into breakouts for EUR/JPY and GBP/JPY which recently hit a fresh 4-year high.
Australian dollar (AUD/USD)
While I have usually maintain strong bull/bear opinions on the Australian dollar, I now find myself very torn. Based on the commentary in the last statement on monetary policy from the Reserve Bank of Australia (RBA), I think the Australian dollar has finally bottomed. However, I am VERY wary of the RBA. I would not be surprised if we learned that the RBA is collectively cooking up new ways to try to drive the currency down. Under these circumstances, I prefer to react rather than anticipate.
The Australian dollar has finally reversed its post-Fed gains, but the W-bottom still looks secure
Last but not quite least is the Swiss franc. I prefer to examine EUR/CHF when thinking about the franc given the tight relationship between the two currencies. A general uptrend remains in place since early September, 2012 when the market first awakened to the notable decline in "downside risks" in the eurozone. The franc is only up 2.5% since then after multiple bouts of sharp rallies, each experiencing notable fades. The Swiss National Bank (SNB) has even seen fit to keep reinforcing its commitment to defending its 1.20 floor on EUR/CHF. Assuming the upward bias remains in place, this is a great time to open up fresh positions against the franc. HOWEVER, I have noticed in recent weeks and months that the franc has tended to catch a bid on what one might consider "risk off" days (see my post "The U.S. Dollar Is Ever So Slowly Losing Its Risk Appeal"). So while the downside seems limited, I think it makes sense to prepare for it in case of large market volatility.
A very choppy 1-year uptrend from the 1.20 floor
Be careful out there!
Additional disclosure: In forex, I may initiate a new position, short or long, at anytime.