E Currency Markets Overreact After Getting Caught Offsides The Dollar

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.

U.S. Dollar Index

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 (euro)

EUR/USD (FXE) broke down below its 200DMA and looks poised for an eventual retest of the March lows. Source: TradingView.com

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Disclosure: short USD/CAD

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