Three Reasons To Buy A Currency
It has been a solid week
for positions which are “dollar short”, most notably EUR/USD and GBP/USD.Â
Technically the damage is severe in the Dollar, the result should be some
sustained moves higher in the above mentioned currencies as well as the AUD/USD,
USD/CAD and USD/JPY.Â
The question is:Â
“Why such carnage in the
Dollar after such a fantastic technical break-out a month ago and continued
solid economic reports?”
There are
basically three reasons to buy a currency. One is based on sentiment, the other
on economic fundamentals and lastly, technical reasons. When the Euro traded at
1.08 last September there was perfect disconnect between the first two,
sentiment and economic fundamentals. Sentiment at the time was that nobody
wanted to own the Euro, meanwhile the economic fundamentals remained very
supportive. Accelerating growth in the US and slowing demand in the Eurozone
would lead to a relative deterioration of the US trade position, while
simultaneously the doubts about the sustainability of US growth were large
enough for European investors to refrain from buying US equities.
There seems to be
a similar situation in FX markets at present. After two massively positive
payroll reports sentiment dictated to many investors that it would be foolish to
short the Dollar. And yet, the economic fundamentals remain unsupportive. US
imports are not slowing down and the persistent current account deficit
increases the pressure on the currency.
This external
deficit story may sound boring for many but it has a very real impact on FX
markets. The trade deficit has to be financed, whether the FX markets pays
attention or not. Exporters outside the US will have to pick up their phones and
sell more Dollars to pay wages in local currency.
The question for
traders to consider now is:Â “Will a handful of solid economic reports
dramatically change the fundamental backdrop of the Dollar?” Frankly, knowing
or thinking you know the answer is not important. Logic tells us that the
Dollar should trade lower as it is presently, but if you always refer back to
Reason #3 as to why people buy and sell currencies, technical reasons, you will
let price action be the final guide.
The daily chart of the Dollar
Index confirms this conclusion. However, as traders, we can never simply draw
such a conclusion and then simply walk away. For now this conclusion/technical
set-up is valid and appears to have some legs to it. However, in this day and
age, a few “choice words” from a central banker or a terrorist attack can alter
that viewpoint in a heartbeat.
On that note, enjoy the long
weekend, I suspect next week will continue to provide some solid ideas in FX.