Forex Prepares to Snap Summer Doldrums

by: The LFB

The summer months of trading have been mundane, and for the most part of June and July the only movement came in spurts of unsustainable price action thrown in here and there, for good measure. With few exceptions, the major currency pairs saw extended side-ways channel trade; together with very choppy chart patterns, that had the ability to completely change both shape and momentum from one session to the other.

The main reason behind these moves seems to be a mix both of low volume and dramatically reduced speculative interest, that coupled with the uncertainty observed in the global economy, created extreme channel trading ranges. Forex currencies reflect the state of any given economic region at any given time; thus a forex pair should theoretically price the spread between the business cycle of any given two countries that are traded against one another.

The ability for the markets to misprice different assets and overshoot targets is accepted, and looking at the bigger picture, traders can normally build a clear idea of what is the appropriate forex price. However, this valuation of debt-to-growth ratios in currencies seems to be the root problem of the current market; there has not been a clear picture.

The equity market saw a very strong rally over the last few weeks, driven mainly by better than expected earnings reports. However, these earnings are 30% lower from where they were one year ago, and moreover, they will not reflect the real economic slack until next quarter. Even worse, these better-than expected results were built on the back of job reduction and investment cuts, which worsen the macroeconomic picture; the same picture that drives the forex valuation.

In the last week of July the market witnessed what happens when the picture does becomes clearer; we get a rally that holds. However, because of being used to things breaking and then failing to maintain new ground, the initial moves are not often trusted to hold. The new market norm of overshooting and then heavily consolidating will now challenge the forex market to hold a value on the strength of regional growth.

The summer norm, of forex pairs blindly tracking global equity trade each day, may soon be gone. The new normal will be increased speculative interest, which has the effect of allowing trends to form, and increasing market participation, which allows the trend to hold tests of support. Both can be seen increasing in the daily average trading range, and daily volume reads.

Disclosure: none