While last week certainly had its share of risk events that helped move currencies, the major theme in currency trading was continued weakening/consolidation for the U.S. dollar.
This week, the weakening will be a key focus for us. We have some very weighty top-tier data events occurring in the next few days.
The key event on the economic calendar is the Federal Open Market Committee (FOMC) meeting and rate announcement today (Wednesday). No one is considering there will be an actual rate change, but what traders and speculators are looking for is the U.S. Federal Reserve comments related to the much dreaded taper of economic stimulus.
This presents an opportunity for profits from currency trading...
Currency Trading on the Fed
When the Fed first discussed tapering quantitative easing in June of this year, it sent markets into a tailspin.
From June 18 to June 24, the S&P dropped its biggest consecutive-day loss on the year, from 1,651 to 1,573.
At that point Ben Bernanke came out to reassure the markets that all was well, and there was no need to worry. The S&P happily resumed its record-setting climb.
There were rumors that the Fed could announce a taper in September, although we knew that was highly unlikely... If indeed the Fed was going to be data dependent on their decision (as opposed to simply following a timing schedule), there was no way that the economy was ripe for any kind of stimulus reduction as the fall quarter began.
And as expected, such was the case, there was no taper and the U.S. dollar sold off, as you can see in this 4H Chart of the EUR/USD. The red vertical line represents the start of the week when the FOMC met. We had a gap open on Sunday, and the real move began on Wednesday.
It has continued unabated, as the euro has beaten the stuffing out of the dollar over the last month with a move up of 350 pips.
Currency Trading Ahead of the Fed
Here's what you should understand about currency trading on Fed meetings...
The QE taper won't be any time soon.
The U.S. economy data has failed to improve substantially - or consistently; we now have shutdown-related losses that aren't known, and September's nonfarm payroll report was abysmally poorer than forecast. Currently, Bloomberg economists seem to have their eyes set on a taper beginning March 2014.
However, we don't need an actual QE taper, as the market is inclined to price in certain volatile actions in advance.
So we have to begin thinking in terms of expectations for that event and not simply wait for its
arrival to see what may happen.
So as we look to the Fed speak out of this week's meeting, we are looking to see if there is any reason to consider a March date for the timing of the taper beginning. Such an acknowledgment will likely send the market reeling again.
This is what that would mean for currency trading:
A strong dollar trade would likely be hitting the markets.
Since we would be looking for the dollar to gain strength, we want to be in the right arena to make the trade. That means the currency trading opportunities appear to be with EUR/USD or the GBP/USD (British pound/U.S. dollar).
Against all the major currencies, this is where we find the dollar to be the cheapest; we'll get the most bang for our buck with these pairs should the dollar start to strengthen.
But what if the FOMC is not all that interested in talking about the future of stimulus? What if they are concerned with the falling jobs numbers and the impact of government shutdown, which is only delayed, rather than resolved, by the recent congressional action. We'll see this this again before the end of the year.
What if the Fed hands us a forecast that implies they will have to maintain (or even increase) stimulus going forward? In that case, we want to be trading where the dollar is already very expensive...where it is already strong against the counter currency in the pair. That means the USD/JPY (Japanese yen).
As you can see from this weekly chart of the USD/JPY, we have been rising strongly in this pair, as the dollar has been beating the yen since January of last year. But we have been recently working into a consolidation triangle that is begging for a break out.
Should the Fed hand us any information that would look like a weakening dollar might be in the forecast, I would be looking to trade the USD/JPY to the downside, as it has so much potential room to run, nearly 2,000 pips from its current price of 97.67 to the recent swing low at 78.00.
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