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Both the U.S. and EU made significant policy decisions last week, here's a brief review of trading implications

US: Symbolic Taper Bullish For Both USD And Stocks

Last week the U.S. provided markets with both the start of a slow tightening process with the start of the taper, yet at the same time convince markets that it stays dovish for the near term, benefiting both the USD and stocks. Quite a balancing act. See here for full details of how they did it, lessons and ramifications.

EU: Symbolic Bank Reform: Bearish for EUR, EU Stocks

Meanwhile, the EU dished up a bank reform policy that perversely seems likely to accomplish the opposite of what was intended; see here for our full special report.

How To Profit

There are a few ways to profit. I omit specific entry and exit points because these are longer term plays that allow for use of a variety of holding periods and thus entry and exit points.

Here are just a few obvious ways for currency traders or currency ETF investors.

How The U.S. Dollar Benefits

Even though dovish policy implies a USD-debasing growing money supply and so typically sends the USD lower, the USD index bounced higher this week, scoring its biggest gains on the Wednesday dovish taper announcement.

Why? Simple, the taper start is still at least a symbolic step towards a coming, eventual tightening anticipated within the coming 12-18 months. That tightening may be gradual, even halting, but the Fed has confirmed, that it is moving in a hawkish direction, and U.S. data continues to confirm and support that trend.

In contrast, the central banks of most other major currencies are either holding steady or biased to further easing.

  • Japan is openly eager to drive the JPY's value far lower.
  • As we imply in our special report on the EU's quiet disaster this week, the ECB is particularly likely to be forced to print money in quantity or risk another, potentially fatal EU crisis if another large GIIPS bank needs aid.

Because currencies trade in pairs (it's the only way you can price them), everything is truly relative, and the Fed now looks positively hawkish compared to the central banks of Europe, Japan, Australia, and others. The USD is thus likely to see rate increases before the other major currencies, (U.S. Treasuries continue their slow uptrend), and that should provide some kind of sustained reversal of the U.S. dollar's long term downtrend versus almost everything, at least for the coming months.

How To Profit Part 1

Here are a few ways to profit. First, we look at some ways to profit for currency or currency ETF investors.

That means long positions in the USD or its ETF proxies like UUP should be long term beneficiaries.

Conversely, because the EUR usually moves opposite the USD, short the EURUSD or its ETF proxies like FXE or go long the ETFs that take short EUR positions like EUFX OR ERO. Note that leveraged short euro ETFs like EUO or DRR or ULE suffer from rapid decay and are only for short term (under 48 hours) positions.

As a side note, our favorite real time sample of retail trader sentiment, the forexfactory.com ratio of EURUSD long/short positioning, remains firmly short the pair, despite its entrenched 18 month uptrend. Average holding period for these traders is 8 weeks.

REAL TIME DAILY CHART OF A SAMPLE OF 400 RETAIL TRADERS OCTOBER 14, 2013 - DECEMBER 20, 2013

Source: forexfactory.com, homepage

How To Profit Part 2

For stock investors, particularly U.S. investors, it means the rally is alive. Technical momentum indicators confirm that (see below).

The current mix of dovish policy AND improving data, along with bullish trend and bullish momentum signals for stocks strongly suggests that the current rally is alive and well.

Another Lesson: Use USD Strength As Chance to Diversify Out Of It

Barring a disaster in the EU (which just became a much more likely at some point, see here for details), the USD downtrend versus most other major currencies (except the EUR, JPY and perhaps GBP) isn't likely to have finished

Long term currency trends tend to be very persistent because it takes a long time to change the fundamentals of an entire country. That suggests that the USD continues its long term downtrend against most currencies and hard assets, as we discuss in depth here.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Source: How Forex Traders Can Profit From The Latest Huge Fed, EU Actions