In the Federal Reserve's latest statement on monetary policy, Chairman Ben Bernanke basically announced that the Fed is giving the economy a blank check:
"If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases."
This forceful action is likely much stronger than already anticipated by the dollar index's roughly 5.5% slide from recent highs in July.
The dollar's plunge continues
It is tempting to believe that the Fed's blank check equates to a bottomless pit for the dollar. If the economy never responds to all the asset purchases, or any other attempt to rev it up, then perhaps the Fed could grind the dollar into complete powder. However, I think that at some point soon the financial markets will stabilize the dollar in anticipation of a stronger U.S. economy, especially relative to the recessionary economies in Europe. This rebound should happen as soon as next week. The euro and the British pound are now stretching in extreme moves in a nearly straight-up fashion. The currency markets often do not tolerate such outstretched moves for long without some kind of notable correction.
The euro's rally against the U.S. dollar has sharply accelerated in the past two weeks
The pound's rally has also picked up steam
In the case of the pound, GBP/USD has followed through nicely. I am now neutral on GBP/USD but remain bullish on GBP/AUD as it retests its 200-day moving average (DMA).
The Australian dollar has rallied again against the pound but faces a critical test of support at the 200DMA
For going long the dollar, I now prefer to play the Canadian dollar. Bank of Canada's Governor Mark Carney has explained in the past that he realizes he cannot allow U.S. monetary policy to get too far ahead of Canada's. Translated, this means that Canada, largely reliant on exports to the U.S., cannot afford for its currency to appreciate too much against the U.S. dollar. I think a pin around parity remains a good base case. I have gone ahead and started building a small position despite the ugly chart.
The Canadian dollar has traded around parity with the U.S. dollar for the last two years or so
Instead of continuing to short the U.S. dollar, I think the next great opportunity is likely in shorting the Japanese yen. As I have argued before, additional monetary easing by the Fed puts renewed pressure on Japanese finance minister Jan Azuni to move on intervening on behalf of a weaker yen. USD/JPY has now punched through support at 78 and threatens to break down to new historic lows. These levels are sure to freshly motivate Japanese exporters to plea for monetary assistance.
USD/JPY finally cracks support at 78, putting historic lows back into focus
Azuni has tried to jawbone the currency lower to no avail and will likely be forced to act to intervene. The timing of such intervention is of course quite uncertain. The euro has recently surged against the yen off lows in July. The pound has risen against the yen off higher lows throughout 2012. So, it is possible it will take a renewed broad-based strength in the yen to trigger intervention.
The pound has gradually rallied off lows against the yen
Source for charts: FreeStockCharts.com
Given the uncertainties, I am not interested in aggressively shorting the yen at current levels, but I am definitely not interested in going long yen. A sudden surge of strength in the yen would serve as an excellent signal to launch a counter trade.
Be careful out there!