Ignore Navarro comments, EUR short story intact

Trading started out quiet enough today, but after the Financial Times reported on Donald Trump trade adviser Peter Navarro's comments on a "grossly undervalued" euro today, EURUSD quickly shot up from 1.07 to 1.0813. The pair is currently trading at 1.0799.

Let's be reasonable for a moment though: The inflation outlook for the euro zone does not support any immediate EUR strength ("base effects"), Mario Draghi's ECB is still broadly dovish, and the year 2017 brings plenty of political risks for the currency bloc with tricky elections in the Netherlands, France and Germany. On the other side of the Atlantic, the Federal Reserve is prepping for as much as three interest rate hikes that should, in theory at least, support the US dollar. In fact, if Trump's economic stimulus works out well, the Fed might even be inclined to hike rates faster or more often. Let's not forget that central banks are independent, either! Trump and his advisers have no real business telling anybody that their currencies should be revalued higher or lower, and if they do, the recipients of that message have absolutely no obligation to obey mighty Trump's orders (even if they come in form of a Tweet, which to my surprise has worked pretty well for the president so far).

What should a trader make of this mess? We must surely brace ourselves for an increase in two-sided volatility during the next few months to come. Any comment from Trump, Yellen and Draghi will violently and without warning push both EUR and USD pairs in either direction. The same goes for news about populist parties in Europe gaining support ahead of this year's elections. JPY pairs will be affected too, because the Japanese yen is still a typical currency for risk-on and risk-off trades.

Looking just at EURUSD, I believe the EUR has no real supportive story going for it for some time to come. Comments from Trump's adviser team won't change that. The euro zone has lots of homework to do, and a possible trade war with the U.S. won't help, either.

Resorting to technical analysis, it is true that the charts look slightly more supportive after today. In the daily chart above the pair managed to break out of its downtrend, which started in November 2016, and in the monthly chart it even jumped back over the long-term upwards trendline support going back to 2002 (second chart above). In theory, a monthly close above the trendline would signal that the previous break lower was indeed a false break, especially since EURUSD failed to permanently trade below the March 2015 low at 1.0458 (red dashed line).

Everything else is still telling me that the EUR short / USD long story is intact, however. As mentioned above, I don't attach a lot of value to Mr Navarro's comments anyway. It's more significant to me that EURUSD further decoupled from interest-rate differentials today (I think it will revert back soon) and that speculative EUR shorts ("smart money") have declined yet another week. That means market positioning is less extreme, thus permitting another extended move lower.

Open positions as of 31/01/2017 9:17pm CET:
EURTRY short from 4.0524, unrealized return: -0.26%

Realized YTD return: +0.7% from 2 trades
Total YTD return: +0.44% from 3 trades

Draghi to serenade markets today, likely non-event

Mario Draghi will preach his usual sermon of persistent risks to the growth outlook today. Like most analysts, I don't expect any changes in the ECB's rhetoric. Draghi & Co. will likely resist changes to their outlook for policy rates or the APP despite the recent uptick in inflation.

With Yellen signalling "a few" rate hikes per year through 2019, this is the ECB's chance to keep the EUR at the current low or even lower levels vis-à-vis the USD. I'm not paying a lot of attention to Trump's statement that the USD was too strong, by the way, because the dollar's path will be determined by the Fed, not by the tweeting POTUS.

Open positions as of 19/01/2017 9:00am CET: Flat

Realized YTD return: +0.7% from 2 trades

The dollar will be stronger going forward

My frequent readers know by now that I've been very vocal about US dollar strength throughout this year. It is true that there have been many a times during the past 12 months when the dollar depreciated against the euro and, in particular, against the Japanese yen. That was usually the case when the Federal Reserve kept the market guessing about its future policy moves, including the timing of its first interest rate hike, or when the European Central Bank could not persuade the market of its capability to sustainably increase inflation through its monetary policies, such as negative interest rates and extensive quantitative easing programmes. However, no matter how tenacious the dollar's sideways range has been (just look at EURUSD, which had been stagnating since April 2015), I've always stuck with my conviction that the US dollar would ultimately emerge from this inconvenient bout of range trading as the stronger currency in comparison to the rest of the G10 currency basket.

The main reason being that the US economy has been able to put its economic recession behind itself earlier than European economies managed to do. This time gap of perhaps one to two years was a strong indicator of increasingly divergent fiscal and monetary policies in the US and throughout the euro zone that would help strengthen the US dollar and, on the other hand, devalue the euro. Although this did indeed happen to some degree up until March 2015 when the EURUSD exchange rate came close to reaching $1.05 but instead came to a halt at the intersection of two long-term trend lines and entered the aforementioned sideways market. I must admit that I greatly underestimated the amount of time it would take for the US dollar to resume its appreciation, and that it would be the election of Donald Trump as the next President of the United States that would trigger the dollar's renewed vigor is still somewhat beyond me.

Anyway, the time has finally come that we're seeing a strong trend in EURUSD again. The only thing that worries me at this time is the pace at which it unfolded. Within merely 10 trading days we went from the election night high of $1.13 to today's low of $1.0568 -- that's almost an eight big figure move without noteworthy backlash! The daily RSI currently reads 22 and other oscillators confirm that the pair is oversold. While I appreciate the fact that such moves often extend even beyond these levels, I must also acknowledge that the previously favourable risk-return profile of the EURUSD short trade has worsened significantly, which is exactly why I closed my USD long trades yesterday. Traders thinking about selling the euro versus the US dollar should think thoroughly before doing so. Personally, I expect a bit of profit taking to begin soon, but I will stand ready to buy the US dollar again once the extreme momentum has abated. The US dollar still has the majority of arguments on its side, and that is not going to change unless the ECB and, more importantly, the Fed will disappoint in December. Next month will be at least as interesting (or should I say, challenging?) as this month turned out to be.

Buy the USD, but against which currency?

I still believe the US dollar will be stronger going forward and I think that its recent weakness presents an excellent buying opportunity. As I wrote in March 2015, there was no reason for the EURUSD exchange rate to go up at that time, unless the Fed would change course and oppose the dollar's strength. Well, that is exactly what happened, unfortunately:

The Federal Reserve has still not hiked rates and some even doubt that it will do so in 2016, while both the ECB and the BoJ have embarrassed themselves by botching up press conferences or entering negative interest rate territory, only to see their currencies go up in value afterwards.

The USD has lost versus most peer currencies, especially the JPY. It's still difficult for me to understand why people have been so concerned about the US economy lately. Every data release that was even slightly below expectations quickly led to more USD selling and EUR or JPY buying. As a result, USDJPY is now fighting not to fall below ¥105 (or even ¥100) while EURUSD recently tried to break above $1.15 (although it has so far failed to do so). The American economy isn't doing that bad, and market participants' obsession with the unemployment rate has reached an outright ridiculous level. At this point it's all about productivity figures!

Anyhow, speculative USD short positions are the highest since 2013. That's a good sign for traders: The extreme EUR & JPY short positions that were the cause of much volatility in 2015 have been reduced substantially, providing new entry opportunities without the risk of extremely sharp moves as in April and December 2015. Market positioning is way more neutral now, which is also a result of investors' inability to interpret central bank actions. Most likely central bankers don't really know what they're doing themselves anymore, so traders are now looking for new reference points that will help them navigate through the muddy waters that are the financial markets. Fundamentals in the US are still better than in Europe and Japan, despite the recent string of disappointing data releases.

But which currency to sell versus the dollar if you share my view? I don't really think the ECB holds much credibility in the markets anymore. Also, Draghi and his team have repeatedly said that they wouldn't introduce new policy measures in the near future because the implemented policy tools needed time to have an effect on the economy. Europe's central bankers are probably too busy discussing their independence from politicians anyway. I expect the EUR to remain range-bound for the time being -- although I must acknowledge that the sideways range in EURUSD has been going on for what looks like a disproportionately long time when comparing it to similar patterns in the exchange rate's history. Be that as it may, the BoJ seems more likely to surprise markets by introducing new easing measures. It is also in a very tricky position now where it has to make decisions within very little room for action around the zero bound. Just how negative can you go, after all? Japan's still fragile economy is in a tough spot here, and I believe both fundamentals and further BoJ actions will reverse the JPY's bout of strength into extended weakness by the end of this year. Conclusion: I'm a USDJPY buyer.

ECB and BOJ may soon buy equities, Reuters reports

As if central bankers hadn't done enough damage already, the masterminds at the helm of the ECB and the BOJ may be considering to buy equities via ETFs, at least according to Reuters. How did they come up with this brilliant idea, you might ask yourself... well, it is to "support market sentiment and stock prices".

With unconventional measures, such as helicopter money, already a part of the public (and perhaps even closed) debate about how to prop up our (so they say) worryingly ailing economies, this should not even be that surprising to be honest: The BOJ has already been buying ETFs, the ECB is buying up bonds wherever it can find them and the Fed has so far chickened out of raising interest rates (and killed forward guidance in the process, but that's another topic).

Let me ask this though: Why don't they simply buy oil, if deflation is really what central bankers are concerned about? Seriously, how does buying equities and thus pushing up stock prices help the average citizen? Doesn't it merely make the portfolios of wealthy people more valuable and hence widen the gap between the middle class and the rich (the playing field is already too uneven for the poor, so let's not even bring them into the equation)? I'm not a friend of conspiracy theories or leftist gibberish about "the 1%", but if stock buying were to become a viable tool for the ECB to "pursue its mandate", as our man Draghi likes to put it, I would really have to sit down and do some serious contemplating about how this market is now functioning versus how it is supposed to work. I thought we were living in a social free market economy, but perhaps I've just been too stupid to see what's been going on these past few years. If what we have right now is not a centrally planned economy, at least with respect to price formation in securities markets and increasingly even access to markets, then I really don't know. What else is there to say?