Dollar Hollar: Despite USD history, the greenback has remained supported since the December FED rate hike in the face of some fairly strong historical cycles that have suggested the USD has a high probability of fading post the first rate hike. So whats different this time and what are the potential catalysts for history to rhyme if not repeat.
One of the primary factors of the current USD bid tone is the well publicized policy divergence theme that has been prevalent in markets for the past 18 months and accelerated with the FED move in December 16 versus its major Central Bank counterpart the ECB who are entrenched in an easing cycle, easing monetary policy several time since mid 2014 in an attempt to contain the Euro’s valuation.
As I have highlighted in prior pieces, historically the USD is replicating prior price patterns as we have moved to and through the first FED rate hike specifically the recent tightening cycles of 1994,1999 and 2004, whereby the markets anticipation of a rate lift off in the US has caused USD out performance versus other major currencies, however, in the months following lift off in three of the four cycles stated the USD gave back on average 5% of the pre lift off gains in the 100 trading days post lift off.
To get a better read on the potential for history to repeat we need to take a closer look at the conditions surrounding the prior cycles. There are a couple of key considerations as to why the USD reacted as it did in these previous years. Firstly, in these prior rate cycles the FED was believed to be less hawkish than the market anticipated after the initial move. Secondly, the global monetary environment was markedly different to the current divergence we are experiencing, as in prior cycles the FED were accompanied by other major central banks who were also embarking on tightening cycles.
Minutes from the December meeting demonstrated that members of the committee interpreted recent economic data as suggesting the economy was expanding moderately and the slack in the employment data had declined considerably. The minutes also highlighted the low inflation environment driven by the collapse in commodity prices. All members of the committee coalesced around the notion that inflation would recover towards target, it was still a source of concern that inflation has remained depressed.
Since the lift off in December the USD has maintained its bid tone registering gains against most major counterparts. Although it would appear prudent for one to be cautious about the potential for history to repeat there are sufficient risks to suggest there is a strong chance of history rhyming if not repeating. In a counter intuitive market theme the EUR has actually been benefiting from risk off market sentiment which has dominated the markets since we opened the book on 2016.
Since last August when we witnessed the first meaningful Chinese Yuan devaluation the subsequent financial fall out in global markets demonstrated capital flows out of the USD into the EUR as traders liquidated risk positions in European assets where they had been positioned for the ECB QE trade anticipating asset market appreciation similar to that witnessed in the US since 2009, the steep declines in risk markets forced liquidation of these positions and hence a flood of demand for EUR. Since the beginning of the year we are seeing that trade develop again whereby the EUR is benefiting from the risk of market mood.
The turmoil in global markets could have a further negative drag on the USD by hampering the FED in terms of the glide path of rater increases in the US, the committee were keen to stress that they were cognizant of global conditions and the potential read through into domestic data from global growth concerns. A walk back from the FED would certainly weigh on the USD and could prove the catalyst for the 5% pullback that has been witnessed in prior cycles.
Technical & Trading Takeaway
We continue to map the Bullish USD scenario the probable path of price as highlighted in the charts, being long against 97.00 is the trade I recommended in recent reports and is playing out profitably for now and is currently running 200pips of profits. Longs from the 97.00 level should now be risk free. While the .9800 pivot survives on a closing basis we should anticipate a sustained breach of the 100 level to a minimum upside objective of 102, 104 in extension where as previously stated I will be looking to reverse long exposure in this area to play for a trend correction.
Remember probabilities suggest thrusts from prolonged consolidation prove terminal in the near term as too many market participants chase price action at poor locations. I am not suggesting a termination of the trend but more that this structure would provide a better trend entry after a shake out of poorly positioned players.
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