Fed on track to hike: USD long

Expectedly, Yellen didn't provide anything enlightening yesterday. The market realized the Fed is still on track to hike rates this year, with March being a "live" meeting (although the hike probability is not high by any means for that meeting). Perhaps traders are still remembering 2016 when the Fed didn't hike as often as had been expected. Traders should forget all about 2016! The Fed entered its rate hike cycle, and it will hike again. Traders should also pay less attention to Trump statements. Let's wait for actual implementations of his promises instead. Regarding his USD rhetoric, it's meaningless. If his administration will deliver on his stimulus promises, which I think it will, that will be inflationary and ultimately positive for the US economy, i.e. it will give Yellen & Co. even more reason to continue hiking rates. It will also be important for the Fed to prove it is an independent institution; the US president has no business pressuring his nation's central bank. Everything is playing into the USD long story at the moment. Don't let Trump noise fool you into thinking anything else.

EURUSD Short 15/02/2017

Quick look at NZDJPY: After I chickened out of putting on a NZDJPY long trade post-RBNZ, the pair is looking constructive again. Trendline support still valid. On hold but definitely interesting.

NZDJPY Daily 15/02/2017Open positions as of 15/02/2017 10:19am CET:
EURUSD short from 1.0795, unrealized return: +2.37%

Realized YTD return: +4.34% from 3 trades
Total YTD return: +6.71% from 4 trades

Expect nothing new from Yellen today

Fed chair Janet Yellen will deliver her semi-annual congressional testimony before the Senate Banking Panel today. I expect nothing new from her today. It's too soon since the latest Fed meeting on 1 February to change course, and the dollar is too strong to hint at a March rate hike, in my opinion. I maintain my EURUSD short position. By the way, US National Security Adviser Michael Flynn's resignation is a non-event for FX, ignore it.

DXY Index 14/02/2017Open positions as of 14/02/2017 08:45am CET:
EURUSD short from 1.0795, unrealized return: +1.77%

Realized YTD return: +4.34% from 3 trades
Total YTD return: +6.11% from 4 trades

Selling EURUSD at 1.0795

I have nothing new to add to my commentary on Navarro and the US dollar's strength from yesterday evening, but I'm putting my money where my mouth is: Sold EURUSD at 1.0795. This is not a near-term trade as I can see the pair going up to 1.0875 or even higher during the next couple of sessions (depending on Fed today & any Trump comments we might get), but in the medium- to long-term I believe the EUR short story will play out well. Read yesterday's post for details.

EURUSD short 01/02/2017Open positions as of 01/02/2017 9:38am CET:
EURTRY short from 4.0524, unrealized return: -0.56%
EURUSD short from 1.0795, unrealized return: flat

Realized YTD return: +0.7% from 2 trades
Total YTD return: +0.14% from 4 trades

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

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.