Dollar hype train accelerates

Market volatility picked up on Wednesday with US Dollar bulls proving victorious in their attempts to take the Greenback to new highs. The Republicans winning control of the US Senate in the Midterm Elections was seen as the primary reason behind the increased USD demand. However, I remain unconvinced that this is one of the reasons for the USD strength.

The theory behind this reasoning is that Republicans are supposedly “business focused”. Therefore, they would appear more likely to add pressure on the Federal Reserve to begin raising interest rates sooner. This idea is simply flawed. For instance, the Federal Reserve act independently from any political party, and, even if the Republicans are “business focused” who is to say the party might not prefer to keep rates low and boost business investment activity? The Federal Reserve will only begin raising interest rates when ready, regardless of who is in control of the US Senate.

The reason for the increased USD demand is far more likely to be correlated to US economic confidence being really high. For example, the Federal Reserve concluded QE, US GDP estimates are surpassing expectations, Manufacturing ISMs are impressing and Consumer Confidence is at a seven-year high. This has all happened in just over a week. Additionally, there are no current indications that Friday’s NFP will disappoint. In fact, optimism for a strong NFP is even higher following the ADP employment change indicating 230,000 jobs had been added to the US economy in September.

Although the Dollar hype train has picked up speed in recent days, investors should be vigilant towards any USD profit-taking either following the NFP or during the beginning of next week. The recent FOMC Minutes already indicated concern among the Fed members regarding the markets already talking about a US interest rate rise, therefore investors becoming tempted to close USD positions remains probable.

Moving on, the major economic story on Wednesday is the UK Services PMI dropping far more than forecast in October. Due to awareness that the UK Services PMI was forecast to marginally decline compared to September, a GBP decline on Wednesday was expected. However, the expectations for a 58.5 Services PMI were far from the mark and the PMI was declared at 56.2 instead. The PMI dropping to a 17-month low encouraged the GBPUSD to plummet by 160 and record a new yearly low (1.5866) in the process.

The larger than expected decline in such a key UK GDP contributor provided another reason to expect a dovish BoE meeting to have been concluded on Wednesday. Following inflation dropping to a five-year low in September, it was already assumed the Monetary Policy Committee (MPC) views on weak price pressures would have become even stronger. Wednesday’s disappointing Services PMI just provided even more ammunition for the BoE to cite a slowdown in economic momentum as another reason to keep rates unchanged. Either way, the chances of a third member of the MPC becoming a dissenter (voting for a rate increase) anytime soon are slim.

Prior to Thursday’s BoE rate decision, the latest Manufacturing and Industrial Production figures are to be announced from the UK. Following a much larger than expected PMI Services decline yesterday – a major UK GDP contributor – any further signs of UK economic momentum slowing would put GBPUSD risks to the downside. Support levels can be found at 1.5964 and 1.5950.

In line with market expectations, the Eurozone PMIs were revised lower in October and this was reflected upon negatively by investors. The EURUSD declined by close to 100 pips at one point during trading, but it shouldn’t be overlooked that the PMIs returned to growth. This at least provides some optimism that the weaker Euro exchange rate might be improving economic fortunes.

Nonetheless, the IFO declining Germany’s growth forecasts on Wednesday afternoon and German Factory Orders rising less than expected highlights the economic concerns surrounding Germany right now. There remains anxiety that Europe’s largest economy is entering a recession and this would obviously have bearish implications on the Euro. Later on Thursday, the ECB is largely expected to leave policy unchanged but President Draghi might use his press conference to reiterate the currently bleak EU economic sentiment. If this happens, the chances are high that the Eurodollar will slip back towards 1.24 later today.

Overall, the market volatility we are noticing in the currency markets at present is unique. You only have to look at both the Eurodollar and Cable erasing the majority of its losses by the time the markets opened on Thursday for evidence of this. Neither move was due to USD weakness or increased UK/EU economic sentiment. There is an old saying in the currency markets that the “trend is your friend”. The EURUSD and GBPUSD are the most popular pairs to trade, but you need to catch the “wave” in the right direction. The major problem in the financial markets right now is that there are no indications at all what direction the “wave” is heading.

The technicals are playing a larger role in directing which direction the currency markets are shifting right now. You just need to look at what’s happened in Gold over the past couple of days for evidence of that. Since surpassing that crucial $1180 support level, I forecast a positive US NFP at the end of the week pulling Gold back to $1153. By Wednesday afternoon, the metal dropped to its lowest level in nearly five years at $1137. Gold’s downside movement is accelerating and an impressive US employment report tomorrow could even send Gold below $1100 for the first time since March 2010.

The Aussie is another perfect example of what a crucial role the technicals are playing. For example, since the Aussie extended below the psychological 0.8642 support level on Thursday afternoon, the pair dropped as low as 0.8564. Many economists predicted the Aussie concluding the year below 0.85. Now that the Aussie has extended below 0.8642, this is possible. As always, such a move would require the right combination between AUD weakness and USD strength.

Written by Jameel Ahmad, Chief Market Analyst at FXTM.

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