Running with the FX Herd-Don’t get Trampled:
Original post on Saxo Bank’s Trading Floor
It is one of life’s little rules that standing in front of a stampeding herd will usually have a bad result. FX traders are very familiar with the adage but like moths to a flame, they can’t avoid repeating it. For the past two and half months, right up until the end of August, FX traders and global financial markets were nearly rabid with fear over the prospect of the Federal Open Market Committee beginning to taper its asset purchases in Q3 or Q4. If that wasn’t enough, they also were fretting about the replacement of the Federal Reserve Chairman, the pending debt ceiling negotiations, civil unrest in Egypt and lately, a possible US military action in Syria. These uncertainties kept the US dollar bid versus most of the major currencies during August which is readily apparent in the following US dollar index chart below.
Source: Saxo Bank
However during this period, USDCAD struggled to make gains above 1.0550, EURUSD couldn’t sustain moves through 1.3150, and AUDUSD based around 0.8890, even though sentiment was very risk adverse. FX traders who arrived late to the party and got long dollars in the middle of August would have had a difficult time booking profit if they weren’t nimble, even though the major trend in all cases still favoured long dollar positions. Break even would have been a result.
USDCAD poised to test medium-term support 1.0250-80
Today, the herd has turned. The US dollar is offered. In USDCAD, the dollar dropped below the key support zone in the 1.0440-80 area, crushed the next defence support at 1.0365 and is poised to test medium-term support in the 1.0250-80 area. Meanwhile, AUDUSD soared through opposition at 0.9075 and then accelerated through resistance at 0.9230 to flirt with major resistance in the 0.9390-0.9410 zone. While not as pronounced, EURUSD is probing resistance at 1.3350 ahead of strong resistance at 1.3440.
WTI crude remains elevated
As of today, the US dollar has retraced nearly the entire July-August move, in less than 10 days, yet only one of the issues that led to widespread demand for US dollars has been resolved and that one, only sort of. The threat of a US military strike against Syria has probably been downgraded to a Code Blue under Homeland Security standards which still leaves Iran as the major villain in the Middle East. Has Tehran replaced Damascus as the next military target? Egypt is still a mess while President Assad’s army slowly consolidates control. FX traders may believe that these Middle East risks have diminished but oil traders seem to have a different view. WTI crude remains elevated (USD 107.71 per barrel) and reflected in the price is concern about supply disruptions from Middle East hostilities.
Timing and amount of Fed tapering are key
The real driver of the US dollar moves since June has been the FOMC and its plans to end quantitative easing. For most of the summer, it seemed that the focus was on the timing of the tapering programme. Would it be September, or not until December? Would it be before Fed chairman Ben Bernanke’s tenure ran out, or after? By the middle of August, the consensus guess was that tapering would begin in September, with details announced at the FOMC meeting on September 15. Last Friday’s US non-farm payrolls release (gain of 169,000) came in well south of the upward revised forecasts and the so-called whisper number which was around 200,000. The knickers were knotted but instead of chatter about a delayed start to tapering, the discussion covered the size of the taper programme. How much will the current USD 85 billion per month be reduced? Is it USD 5 billion, USD 10 billion or even USD 20 billion less each month? What amount is bullish US dollars or what amount is bearish US dollars?
Discussions surrounding the appointment of Mr Bernanke’s successor could reignite US dollar demand, if only due to uncertainty about the future direction. Noted hedge fund all-star, Stan Druckenmiller, founder of Duquesne Capital management is not only concerned about the end to QE, but said in a Bloomberg interview that "it’s pretty naive to say that the next Fed Chairman won’t matter".
Significant USD buying at Japanese year end
September is also month and quarter end with the added element of the Japanese year end included in the mix which could lead to significant US dollar buying on portfolio rebalancing.
FX traders may be in danger of being caught bopping when they should have been weaving. They appear to have significantly lightened their long dollar positions which were accumulated, in part due to uncertainty surrounding the September FOMC decisions. The FOMC concerns are still very real and any decisions that will be made are still murky. I think that if you are running with the bearish dollar herd in this environment, you run a real risk of being trampled.