FX.co ★ EUR/USD rally will not bring the USD index down!

While we have been observing a serious rally in the EUR/USD market and despite the fact that EUR is a major currency accounted for the USD index calculations, the USDX was quite stable in the recent weeks…

The USDX market

During the past week we observed a downtrend in the USD index market: the index returned back to the level of 79.00. After the USD value varied between 79.70 and 80.20, a volatility breakthrough happened which resulted in a strong USD value decline. After the daily support at 79.35 was broken through, the next support formed at 79.00 was tested (see Figure 3).

According to the Commitments of Traders report published on the 1st of February 2013, hedgers do not expect growth in the market, which is indicated by the hedger COT index drop to 58% (-3 percent points comparing to the previous week) and the Williams’ commercial index decline to 46% (-1 percent point). The net positions of hedgers returned to their beginning of December 2012 values when the USDX was just at the same level (see Figures 2 and 3).

The large speculator and small trader COT indices are equal to 43% (+4 percent points) and 28% (-12 percent points) respectively. The interest is quite but not record low in the market: the COT index is equal to 22%.

Summarizing, none of the three categories of traders or the interest indicate that the USD index is under- or overvalued. Probably, traders have not yet fully reacted to the USD decline or they expect it drop to 78.51.

Figure 1: USDX futures and options data, the COT indicators. History: from Jul 2012 to Jan 2013.

Figure 2: Net positions of hedgers, large speculators and small traders in the USDX market. History: from Jan 2011 to Fed 2013.

It is clear that the increase of the USDX from 79 to 81 in the second half of December 2012 was the whole uptrend. Currently, there is no fundamental reason for the USD to become significantly stronger relatively to other currencies but the decline is also limited by two main factors. First, the monthly support at 79.00 was tested and it is not easy to break through so strong levels. Second, a triangle was tested at the end of the week, as well. Collecting the puzzle, the price is also highly limited from the bottom. There is still a possibility for a short-term decline up to 78-78.50 because monthly levels are fundamental ones but they can be broken though in a daily time frame for approximately a week. However, the most probable scenario for the upcoming week is a volatility decrease and a flat trend in a diapason from 79.00 to 79.50. The daily support at 79.35 may work as a resistance.

Figure 3: USDX, daily candlesticks. History: from Mar 2012 to Feb 2013.

The EUR/USD, GBP/USD and USD/CHF markets

While the USD has been relatively quiet during the past weeks, a serious rally has been observed in the EUR/USD market! While many expected the EUR/USD to decline, it hit through both daily and monthly resistances at 1.35.

According to the Commitments of Traders, hedgers who are operating in the EUR market consider market to be overvalued: the hedger COT index is equal to 0% for three weeks (see Figure 4) and the net positions have reached lows of July 2011. Since August 2011 net positions of hedgers were positive! The large speculator and small trader COT indices are equal to 100% and 93%, respectively also indicating that the EUR is seriously overvalued relatively to the USD.

Figure 4: EUR/USD futures and options data, the COT indicators. History: from Jul 2012 to Jan 2013

At first, we could believe that the uptrend was moved by Mario Draghi’s speeches, but it is too much respect for him. He played a featured but not the main part in this trend. Observing the EUR market in the daily timeframe, it is clear the uptrend is very strong. After 2-week variation between the daily levels at 1.3250 and 1.3400 the exchange rate not just reached the monthly resistance at 1.35, but has broken it through. Moreover, there was a strong Fibonacci level 38.2 which was drawn at the monthly timeframe too.

Figure 5: EUR/USD, weekly candlesticks. History: from Mar 2012 to Feb 2013.

There is a large potential for the growth in the market because it is limited at best at 1.41-1.4150 where the weekly resistance and another Fibonacci level have been formed earlier. In addition, in July 2011 the exchange rate was close to 1.41-1.42, so we can expect that the exchange rate will reach that level before we see a downtrend in the market. Considering short-term forecast for the upcoming week, the most probable scenario is finally a correction back to the monthly resistance at 1.35 which will play a supporting line role.

The growth in the EUR/USD market will drive a decline in the USDX market. However, it is going to be offset by the continuing growth in the USD/JPY and decline in the GBP/USD.

Figure 6: EUR/USD, daily candlesticks. History: from Mar 2012 to Feb 2013.

Currently, market participants do not consider the GBP/USD overvalued which is not surprising after such a significant drop of the exchange rate from 1.63 to 1.58. One week was enough for traders to adjust their position and the hedger COT and WILLCO indices increased to 72% (+28 percent points comparing to the previous week) and 62% (+26 percent points), respectively. The large speculator and small trader (investor) COT indices are equal to 45% and 7% respectively. Small traders were the fastest to adjust their positions. However, the open interest continued growing and the COT index reached the level of 82% which may be an indication that traders are trying to push the market even lower. Is there a place for that?

Figure 7: GBP/USD futures and options data, the COT indicators. History: from Jul 2012 to Jan 2013

Although a large volatility increase was observed in the market, the exchange rate has not moved much comparing to the closing rate on Monday 28. Currently the exchange rate is varying close to the weekly support at 1.58 and Fibonacci level at 23.6 formed in a monthly timeframe. If at the beginning of the next week the Fibonacci level will be broken through, the exchange rate will continue declining to1.55 or even 1.53.

Figure 8: GBP/USD, daily candlesticks. History: from Mar 2012 to Feb 2013.

After the USD/CHF rate dropped from 0.94 to 0.91 for the second time, the market participants changed their minds and believe it is a sufficient decline to stop considering the Swiss franc to be highly overvalued relatively to the USD. For example, the hedger COT index is equal to 36%. The open interest is record low; as a result the COT index indicates that market is slightly below its fundamental values.

Figure 9: CHF/USD futures and options data, the COT indicators. History: from Jul 2012 to Jan 2013

The market has tested the weekly support at 0.9100 and after reaching the monthly support at 0.9000 has returned back to 0.91. The exchange rate can decline to 0.9000 but the most probable scenario for the next week is low volatility and a flat trend in the market.

Figure 10: USD/CHF, daily candlesticks. History: from Mar 2012 to Feb 2013.

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 on the Commodity Futures Trading Commission’s website www.cftc.gov.

Information regarding the interest rates mentioned in this article can be found on the ECB and BoE official websites.

The COT Indices used in this review are calculated using 26 week historical data. The Standard Deviation indicator takes into account volatility of last 5 days.

Open or close your position only after 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.