FX.co ★ QE3 impact on the USD value and trends in major currency pairs

The last Commitment of Traders (COT) data published on 14th of September 2012 includes market participant reaction onto Ben Bernanke’s recent speech at Jackson Hole, Wyoming. Ben Bernanke’s QE3 start announcement almost outranks the Commitments of Traders data; thus, it is integrated in the fundamental analysis of this article. Find out what to expect tomorrow from the currency markets!

Ben Bernanke starts a QE3

As long as, the Financial Crisis of 2007-2008 still presents in the world economy and consequent crises affected the United States, the US economy is experiencing problems. I would like to repeat the part of Bernanke’s speech where he states that Fed is ready to act if it is required:

"Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

The USDX hedgers have already expected USD depreciation prior to Bernanke’s speech. On 24th of July the COT indicators had already been in their critical zones for two weeks and that day the fundamental signal reached its peak. (The peak is marked with a red circle in Figure 1 and with a red vertical line in other figures). Later we observed a stable downfall in the USD dollar index (USDX) value which affected major exchange rates. However, even if hedgers saw that USD is overpriced, they probably did not expect as strong decisions of the Fed chairman as he made. Otherwise, we would see hedgers holding considerably more short positions and a zero value of the hedger COT index. Currently, there is no indication of the USDX undervaluation from hedgers’ point of view.

Figure 1: USDX futures and options, weekly candlesticks and the COT indicators. History: from Sep 2011 to Sep 2012.

Probably the current trend we observe in the market (Figure 2) will continue further because a new money inflow from the Fed and cut in interest rates will decrease the attractiveness of USD in the nearest future. There is a possible correction in the beginning of the next week because the USDX reached the weekly supporting line at 78.60 and the next is the monthly supporting line at 78.00. A confirmation of the downtrend continuation will be a breach of these supporting lines.

Figure 2: USDX futures, daily candlesticks and the ATR. History: from Nov 2011 to Sep 2012.

On 28th of September EUR/USD, USD/CHF and USD/CAD traders reported their long and short positions moving the COT indices in critical areas of 0-20% and 0-80%. COT indices indicate we should expect USD to become stronger in the nearest future. From then onward the COT indicators stayed in their critical zones. The same picture we observed earlier within AUD/USD and USD/JPY markets where currently rates returned to their beginning of August 2012 values. Currently, in the EUR Futures and Options markets, the Index COT: hedgers based on the hedger net positions is equal to 8% meaning hedgers expect a depreciation of EUR against USD. Other traders, large speculators and small traders, also give us signals to expect a downtrend in the market. The large speculator and small trader COT indices are equal to 88% and 100%, respectively.

Figure 3: EURUSD futures and options, the COT indicators. History: from Sep 2011 to Sep 2012.

In other four major currency markets: USD/CHF, AUD/USD, USD/JPY, and USD/CAD traders are also indicating a trend reversal. The market insiders, hedgers, have accumulated extreme net positions moving the hedger COT indices values into the critical areas of 0-20%. Their signal is supported by extremely high values of the large speculator and small trader indices. Moreover a high level of open interest indicated by the Open Interest COT indices values in zones of 80-100% indicates an overheating situation in the markets. (Reminder: all COT data is collected from futures and options markets where USD is a base currency).

Figure 4: CHFUSD futures and options, the COT indicators. History: from Jan 2012 to Sep 2012.

Figure 5: CADUSD futures and options, the COT indicators. History: from Jan 2012 to Sep 2012.

The fact that all but one major currency pairs’ traders indicate the same trends means these trends are not going to be driven by currency specific factors. These trends are associated with each other and are driven by one major factor – USD value.

The only market, where market participants to do not indicate a trend reversal is the GBP/USD market. Yet the futures and options hedgers have not accumulated very low net positions, and large speculators have not accumulated very high ones. However, the Open Interest COT index is equal to 82%, market is overheating and almost all small traders play the uptrend: the small trader COT index jumped from 59% to 89% just in one week! If you observe the Figure 6, you can find that all indicators are moving towards critical areas. I believe it is a soon we will receive fundamental COT signals from all major exchange rates traders.

Figure 6: GBPUSD futures and options, the COT indicators. History: from Jan 2012 to Sep 2012.

It is important to understand that the COT data indicates undervalued USD relatively to the major currencies mentioned above. However, yet there is no sign of trend change in the USDX market itself. In addition, the fact that USD might be short-term undervalued relatively to other currencies does not mean it can’t fall even lower. Finally, Ben’s actions following his speech in Wyoming may have the strongest impact on the trends we will observe in the currency markets.

If the USDX will continue dropping, we will observe continuation of current uptrend in the EURUSD market. Currently, the exchange rate stopped in front of the weekly resistance at 1.3275. The growth without a correction is limited which is a good sign if you want to catch the possible uptrend continuation and enter the market with adequate risks.

Figure 7: EURUSD, daily candlesticks. History: from Nov 2011 to Aug 2012.

Summarizing, although there are signs of USD undervaluation relatively to major currencies, the question is if we observe a correction of the USDX, EUR/USD and other foreign exchange rates and a continuation of the downtrend in the USDX market or an uptrend. A confirmation of current trends’ continuation is a breach of supporting lines and resistance levels.

Information about the analytical review and forecasts

The fundamental analysis is based on the Commitments of Traders (COT) data published by the Commodity Futures Trading Commission (CFTC) and the cross-market connections. The technical analysis is based on support and resistance levels.

More information regarding the COT data can be requested from the author of this review or found at the Commodity Futures Trading Commission’s website www.cftc.gov.

The COT Indices used in this review are calculated using 26 week historical data.

Open or close your position only after a careful consideration. The additional analysis is needed to identify the points for the entrance into and exit from the markets bearing in mind your own money management strategy. Author is providing the key information regarding the markets and presents his opinion about the markets taking into account his uniquely specified trading strategy.