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Dollar Strength Envelops Currency Markets

Dollar Strength Envelops Currency Markets
June 20th, 2013
Author: Marcus Holland

Volatility jumped back into the currency markets, with the dollar gaining strength almost immediately after the Federal Reserve announced its interest rate decision and Chairman Ben Bernanke began to discuss the state of monetary policy. It is clear that although the economy continues to expand at a modest pace, the Fed is closer to reducing its bond purchase program than they have been in the past and although the Chairman view a tapering as different from tightening, market participants seemed to be looking for anything to generate market volatility.

The Federal Open Market Committee changed their forecast on the US economy reporting that the unemployment rate will decline more quickly than they had previously expected, moving to a range between 6.6 percent and 6.8 percent by the middle of next year. The Federal Reserve also changed their medium term forecast on inflation and that price would rebound next year, rising closer to the 2 percent rate than the current rate of 1.4%. The Fed uses the Personal Consumption Expenditures number to gauge inflation and investors will be keen to see this report at the end of June.

Chairman Bernanke's comments should not have come as a surprise to market participants, as he has continued to discuss the same issues at every meeting. The most surprising move which change the current environment was the quick back up in US yields.

Dollar Strength 20-06-2013

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The yield differential between the US and German quickly moved in the US’s favor, dropping down to -90 basis points which is the lowest seen on the 10-year yield differential in the past 5-years. Higher yields in the US make the current more attractive which is one of the issues that have led to a much stronger dollar. Despite a decline in the EUR/USD currency pair, the exchange rate will likely continue to be under significant pressure given the decline in the yield differential. US 10-year yields moved as high as 2.35%, which is the highest level seen since February of 2012.

Recent economic data does not support the back up in treasury yields which will likely rally if the ISM manufacturing report and the jobs numbers do not confirm the uptick in economic activity investors are basis their current analysis on. Jobless claims which were reported on Thursday showed a labor market that continues to struggle.

Dollar Strength 20-06-2013-2

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The EUR/USD sliced through support levels near the 10-day moving average near 1.33, and will likely continue to move lower and test the 50-day moving average near 1.3080. Momentum is clearly negative with the MACD (moving average convergence divergence index) generating a sell signal. This occurs when the spread (the 12-day moving average minus the 26-day moving average) crosses below the 9-day moving average of the spread (shown by the blue arrow). Support is currently 1.3175 ( while the RSI moved from overbought territory to 50 within one day reflecting a sharp market movement and declining momentum. The print of 51, show that there could still be room to run on the downside as the RSI is in the middle of the neutral range.

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