US Dollar History Shows High Risk Of Reversal On Post-Summit Plunge

By David Rodriguez, Quantitative Strategist

Fundamental Forecast for US Dollar: Bullish

A remarkably volatile end to the week of currency trading left the US Dollar (ticker: USDOLLAR ) sharply lower across the board, and a critical stretch of US labor market data and global central bank interest rate decisions set the stage for big moves through the first week of the new month and quarter.

The Dollar heads into a potentially pivotal stretch with weakness as the Dow Jones FXCM Dollar Index posted its single-largest daily decline since the European Union announced its previous grandiose bailout agreement in October, 2011. Fitting—the recent US Dollar sell-off started on the announcement of the newest bailout agreement from the highly-anticipated European summit .

What has happened in the past is never a guarantee of what will happen in the future, but it is very interesting to note that the tremendous EURUSD rally on the 10/27/2011 summit marked the exact Euro top. The USDOLLAR likewise plummeted and bottomed on that day, going on to surge into the following week and the rest of the year.

Could history repeat itself? It’s certainly possible; the beginning of the week, month, and quarter means the time is right for an important turn in trend. Yet even the purest of market technicians would agree that the coming week of fundamental event risk could make or break USDOLLAR price action through the foreseeable future.

We cannot understate the significance of seasonality in forex markets , and the coming days could easily set the tone for the month of July and the third quarter of the year. With that in mind we’ll pay especially close attention to Friday’s US Nonfarm Payrolls data release. The usual mix of pre-NFP economic data and similarly important Reserve Bank of Australia, Bank of England, and European Central bank rate decisions will keep traders on their toes through earlier price action.

Expectations point to another week of mostly disappointing US economic growth figures, and the US Nonfarm Payrolls report will likely show that the domestic unemployment rate remained stubbornly high on lackluster jobs growth. Yet market reactions to the recent European summit announcements emphasize that setting a low bar is not necessarily a bad thing. Indeed, low forecasts leave ample room for positive surprises and potentially a US Dollar-bullish reaction to NFP data.

We’ll otherwise keep an eye on key central bank rate decisions starting with the Reserve Bank of Australia and finishing up with the Bank of England and European Central Bank. Each decision is contentious and each of the RBA, BOE, and ECB could rattle markets. According to Overnight Index Swaps, the RBA is quite unlikely to move rates. Yet Aussie Dollar traders will want to see how the central bank reacts to global financial market turbulence and implications for domestic yields. Any pronounced surprises could carry over into other high-yielding and relatively high-risk currencies against the safe-haven US Dollar.

The same Overnight Index Swaps show a non-trivial probability that both the Bank of England and European Central Bank will further ease monetary policy. The BOE may expand its balance sheet and buy UK Government debt as a method of quantitative easing—increasing the money supply and presumably weakening the value of the British Pound. Interest rate traders predict a 40% chance that the ECB will cut interest rates on clear European stresses. Both events could really force major moves in European currency pairs—especially against the benchmark US currency.

It should be another eventful week of forex trading, and it is little exaggeration to claim that the coming days could set the tone for US Dollar price action through the coming month and the rest of the quarter. - DR
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