Forex Investment and Currency Trading

There was a general consensus that the USD looks overdone at these levels, both against the majors and the Emerging Markets (EM), is likely to retrace.

The short-term market now looks significantly long USD. The latest IMM Commitments of Traders
data through 22 August showed that speculators were net long USD against six major currencies
(EUR, JPY, GBP, CHF, CAD and AUD). In addition, systematic trading models now appear long USD against EUR, JPY, GBP, CHF, AUD and NZD. Option risk reversals have also moved in favour of USD calls against most of the majors, another good sign of short-dated demand for USD. With US data remaining weak in Q3, market expectations for Federal Reserve interest rate hikes are starting to recede. Moreover, rate expectations for monetary easing outside of the US may be overdone near term. Several European Central Bank (ECB) officials made clear this week that there is no likelihood of an ECB rate cut any time soon. Indeed, one official went so far as to suggest ECB policy rates are already accommodative. Relative to money supply growth and current inflation levels, it is hard to argue against this, supporting the view that the ECB will keep rates on hold into 2009.

Finally, the USD looks overdone on technicals. The DXY is peaking after putting in a small double top above the 77 level and MACD is showing the first SELL signal in many months. Indeed, MACD is turning down from the highest levels in around two years. In line with all of this, oil appears to have found a short-term floor ahead of its 200-day Moving Average (MA), which is currently at 111.12. Short term, the USD looks set to retrace part of its gains over the last few weeks. However, there are plenty of real money accounts and other investors that missed this USD rally and will be waiting to buy into any sustained USD dips. Moreover, one should remember that currencies such as the EUR, GBP, CHF, AUD and NZD remain overvalued against the USD on REER or PPP terms. EM currencies are better valued, but even they will weaken further as growth slows into next year, commodities weaken further and central banks encourage weaker – not stronger – currencies to support exports.