The Federal Reserve did its best to seal the deal on my call for a bottoming in the U.S. dollar. The Fed’s message acknowledging increasing inflationary pressures in the American economy appeared to catch currency markets offsides on the dollar. The rush to adjust has the look of an over-reaction even if directionally correct.
After its latest statement on monetary policy, the Fed appeared to announce peak dovishness. The path ahead is necessarily more hawkish. The Fed earlier sent signals on its bullishness on the American economy and hinted that it sees signs of exuberance in financial markets. Accordingly, the acknowledgement of the inflationary implications of stronger than expected growth is quite consistent with both the tone and intent. Financial markets reacted swiftly and in extreme fashion. For example, the U.S. dollar index (DXY) rocketed straight up.
The U.S. dollar index (DXY) soared its way to a breakout above its 50-day moving average (DMA) and then its 200DMA. Source: TradingView.com
The Euro
I shorted the euro against the U.S. dollar as a bet on a bottoming in the U.S. dollar. EUR/USD plunged so far and so fast that I took profits in the midst of the selling. The concentrated move is extreme given the consecutive closes below the lower Bollinger Band (BB) with unrelenting selling pressure. With time, offsides market participants should gather their wits and find fresh reasons to bet against the U.S. dollar.
For example, the Fed’s newfound hawkishness is clouded by the promise to remain extremely accommodative for quite some time. Moreover, I fully expect the speaking tour of Fed governors to feature more soothing and familiar tones of dovishness. President and CEO of the St. Louis Fed James Bullard created the waves that merely confirmed that the hawkish contingent of the Fed is active and has influence.
EUR/USD (FXE) broke down below its 200DMA and looks poised for an eventual retest of the March lows. Source: TradingView.com
The Canadian Dollar
The Canadian dollar (FXC) also beat a hasty retreat against the U.S. dollar. Given my on-going bullishness on the Canadian dollar, I interpreted the extreme upward push in USD/CAD as an opportunity for “bargain shopping.” I replaced my short EUR/USD with a greater accumulation of short USD/CAD. I figure the Fed’s move gives the Bank of Canada (BoC) more room to express its own bullishness. Economic conditions permitting, the BoC can even consider floating its own more hawkish commentary.
As a commodity-related currency, the Canadian dollar received an extra heavy dose of selling pressure. Once the over-reaction ends, commodity-related plays should get fresh bids as good bets on stronger global economies in the future.
USD/CAD went parabolic as it accelerated higher with multiple closes above its upper Bollinger Band (BB). Source: TradingView.com
The Overreaction
The Federal Reserve tried to reassure markets that it will move monetary policy consistent with a booming economy. Monetary policy will even remain highly accommodative. As a result, I consider the rush to get back onsides with the U.S. dollar to be an extreme move in the short-term. However, the U.S. dollar tends to sustain moves above or below its 200DMA. While March’s breakout proved quite transitory, I am watching for signs that the typical behavior is back in play. A break above the March peak will confirm that this time the dollar will stay aloft for a sustained period.
In the meantime, I expect last week’s sharp reactions to cool down and usher in reversals. If USD/CAD fails to break below its 50DMA one more time, I will need to acknowledge the likely end of the trade fading USD/CAD rallies.
Be careful out there!
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