My colleagues have been urging me to write a weekly commentary on Bitcoin/Cryptocurrencies. However, although my interest in the sector is growing, I am not sure that I am nowhere near close enough to the action to comment. I will continue to read as much as I can about this new phenomena, but in the meantime, we will stick with traditional fiat currencies. So here goes.
The US Dollar, having enjoyed a reasonable bounce from the mid-September lows, is struggling to maintain its balance as we head towards the end of the year. The weakness is apparent even though interest rate differentials appear to be supportive. The most obvious explanation for the Dollar weakness seems to be that investors and traders continue to expect the Fed to be more dovish than their forecasts suggest.
Frankly, we can build both bullish and bearish Dollar scenarios at the current time, and with price suggesting the Dollar is struggling a bit, we will err on the cautious side in the short term until proven otherwise. But we are not sure that any upcoming Dollar weakness, if seen, will be as broad and persistent as it was between April and September. Let’s jump in and have a look at a few charts to develop our thinking here.
First up, the Euro seems to be leading the charge against the Dollar. Why so? Well, economic data shows that the Eurozone is performing pretty well and perhaps signs that Germany may not have to have another election help. But it could also simply be that if traders want to sell the Dollar, they will first buy the most liquid alternative, and that’s the Euro. It could also be more structural, as the Dollar’s reserve status seems to being chipped away constantly. In chart 1 below, we can see that the Euro rose strongly between April and September, and that the recent downward price action broadly found support at the previous highs of the last few years. From the most simple of technical perspectives, we think that the recent move lower from about 1.21 to near 1.15 looks more corrective in nature, and that the Euro has to at least trade back to the September high of around 1.2100.
Chart 1 – EUR/USD weekly price graph with 21 week moving average
Drilling down to a shorter time frame, in chart 2 we have shown the daily price graph. We have shown two resistance lines on the chart. One being a downward sloping trend line (in white) drawn off the high in September, and also a horizontal line (in red) drawn from the high in mid-October. On Tuesday of last week, having already broken the downward sloping trend line, EUR/USD appears to have tested the same downward sloping trend line from above and reversed higher. On Friday, EUR/USD moved higher and traded above the highs seen in mid-October.
Chart 2 – EUR/USD daily price graph with 21 day moving average
From a purely trading perspective, as noted, we should really now expect EUR/USD to carry on higher and at least trade to the 1.21 area. If this level is exceeded, price may even extend towards the 1.25 area (although we are less sure about this at this stage). First support is in the 1.17 area, and for the bullish Euro thesis to remain valid, price has to remain above 1.15 area.
Moving onto Sterling, the situation does not look quite as robust as the Euro. Chart 3 shows the daily movements of Sterling versus the Dollar, and we think the most important technical feature at the moment is the gently rising channel shown. If this interpretation is correct, then we should look at this sideways type movement since late September as a correction of the decline from 1.3650 to nearly 1.30, which should at some point lead to a test of 1.30 and below.
The price action on Friday just may be of interest as well. Sterling did rise against the Dollar, but the advance was a lot less robust that the Euro’s advance, indicating perhaps some underlying relative weakness in Sterling. Furthermore, price traded right up to the top of the channel during Friday, but began to fade away into the close. The way we are looking at this is that Sterling may be close to a short term peak against the Dollar, and we will hold a bearish trading bias so long as price remains below 1.3380 area on a closing basis.
Chart 3 – GBP/USD daily chart
Let’s quickly take a look at two more currencies; the Aussie Dollar and Japanese Yen. The Aussie Dollar has been amongst the weakest of the majors during the Dollar rally that began mid-September. We in fact highlighted the Aussie Dollar a couple of times in recent months as potentially a weaker currency play, and our view remains bearish. Chart 4 shows that price remains in a steady downtrend, and we are looking for the rally in the last week to fail around about current levels, or if the Dollar is weaker than expected, we could see a rally up to the 0.7700/30 area. We have highlighted before how the Reserve Bank of Australia remains quite dovish, and this is still the case. We also harbour big worries over the level of household mortgage debt and the Australian property market, but we’ll leave that story for another time.
Chart 4 – AUD/USD daily price graph with 21 (gold) & 50 (purple) day moving averages
The Japanese Yen may be the most unpredictable major currency at the moment. Aside from stories that the Bank of Japan continue to play around in the market, price itself is smack bang in the middle of a 108 to 115 trading range, as can be seen in chart 5. When we analyse market positioning, the Yen is the only currency where speculators are holding a large short position. The net speculative short position is large enough to make us worried about selling the Yen.
There is also a growing feeling that the Bank of Japan is laying the groundwork for a subtle shift in policy next year. Subtle perhaps being the word, as when policy is as extreme as it is in Japan today, and with the knowledge that any major reversal could have seriously negative consequences for Japanese financial markets, the Bank of Japan are in a dark corner that they don’t know how to get out of. But there is talk that they may shift their yield curve control policy, and instead of targeting the 10 year yield at zero per cent, they will shift that to the 5 year yield. This would allow the 10 year yield to trade more freely, and presumably with an upside bias which, all other things being equal, would be positive for the Yen.
Chart 5 – USD/JPY weekly price chart
So, at the moment, we are somewhat agnostic on the Yen, but with a bias to look for opportunities to buy as speculators may have to cover their short at some point, especially if the market perceives that the Fed will be more on the dovish side of the ledger, and/or risk assets ever have a period of corrective price action.
Looking at some of the major currencies, we get the overall picture is a mixture of themes, without one dominant one. When we see this sort of backdrop, we think we need to be careful not to become married to any one theme, and that we should maintain a flexible and more tactical approach as the market may switch focus very quickly.
As we see it, the Euro is currently the strongest of the major currencies, followed by the Yen. The Antipodean currencies are at the bottom of the pack, and the US Dollar is somewhere in the middle. We think the factors that the market is focusing on for the Dollar can change quite quickly, although tax reform seems to be taking a little longer than the White House would want. The UK did not have a great week in our opinion, with growth estimates reduced and borrowing expectations increased in the Autumn Statement. Despite being a relatively cheap currency, the UK has a monstrous task ahead, and we think that Sterling can sit near the bottom of the pack.
With Central Banks trying hard not to rock the boat, or make any obvious policy errors, we doubt that we see any major moves in the FX markets between now and year end. Yet, after such a long period of calm in global financial markets, we have to suspect that volatility will increase at some point soon. By maintaining a flexible and tactical approach in the short term, we think that we will have the opportunity to identify future changes in the early stages of their development.
Stewart Richardson
RMG Wealth Management
