How to trade the FX markets into the final part of 2015
Moving into the final part of 2015, the divergences in central bank measures are going to be the main themes ahead of key central bank meetings in December. Nearly seven years after the previous rate cut, the FOMC is ultimately preparing the markets for a lift-off, while the ECB, Chinese and Japanese central banks are considering more easing policies to keep their respective financial systems more sustained.
The latest U.S. jobs data satisfies the Fed’s conditions for pushing interest rates and the strong prospect of tightening next month should continue the greenback’s advancement over the next few weeks. Interest rate futures point to a 66 percent possibility that the Fed will increase rates at its December 16/17 meeting, setting policy divergences between it and other big central banks strongly in play.
All G10 central banks with the exception of the BoE and the Fed have each cut interest rates or sustained a QE agenda. So the best way to trade the FX pairs into year-end is to ride the monetary divergence wave. The best currencies to buy the dollar against are the ones whose central banks are open to the proposal of extending stimulus in the upcoming months. This includes currencies such as the Euro, Canadian dollar, New Zealand dollar, Norwegian Krone, Chinese Yuan, Norges Bank and the Riksbank. The Japanese Yen and Australian dollar could be included in this basket because their data has been weak but these central banks have been unwilling to confirm the market’s acceptance that they should ease.
The most popular trade is selling EUR/USD because the ECB has been taking every opportunity to insinuate that stimulus could be increased this month and the Fed has done the exact opposite. This week’s move took EUR/USD beyond its previous multi-month low 1.0595 and as denoted in the chart below, there is no support for the currency pair until 1.0520, the April low. We know that there will be major support at 1.05 and 1.0460, the 12 year lows but past that, there is no major support until parity.
(Source: Arjun Lakhanpal’s EURUSD Chart from my MT4 Platform)
Against this backdrop the USD is likely to extend its rally in the coming months, particularly against the EUR, as the ECB is still in easing mode. Unless ECB bureaucrats back away from their call for more stimulus, EUR/USD could test 1.05 in the upcoming weeks as traders position for easing from the ECB and tightening from the Fed. While the path of the USD is broadly shared, the length of the rally and the conviction about the direction are highly disputed as we still do not know if the Fed will continue with a rate hike.