The world's reserve currency, the US dollar, has experienced sustained demand in recent weeks as uncertainty grows amid rising coronavirus cases and runaway inflation. Mounting price pressure has led to louder calls for the central bank to tighten its monetary policy, with the US Federal Reserve hinting at this possibility several times over the past couple of months. Though the greenback has been trading slightly subdued following a sell-off across shorter-duration Treasury bonds, the consensus is that the Fed will announce the long-awaited start of its stimulus tapering at the regulator's upcoming meeting on Wednesday. Such a firm move towards a more hawkish stance will likely buoy the dollar, prompting a rise in demand for US Treasury bonds that should help the US national currency strengthen against the other majors.
Bad news for the Fibre
The EUR/USD pair has been on a protracted downtrend for some time and seems to have moved into a consolidation phase around 1.1600 this week. However, a combination of inflation woes and Fed stimulus tightening is likely to drive the euro down to new local lows over the coming weeks. In fact, Commerzbank's Team Head FICC Technical Analysis Research, Karen Jones, expects the pair to challenge the recent low of 1.1522, to begin with, before slipping to 1.1366 thereafter.
Let's not forget that Europe and the single currency have their own unique problems right now. First, there's the ongoing energy crisis that has seen natural gas (and, by extension, electricity) prices rise several-fold in the space of a few months. Then, there's the nascent COVID wave that threatens to plunge several European countries back into lockdown. Looking at the technicals, EUR/USD has just failed a smidge ahead of the 55-day MA at 1.1694 and the 1.1696 five-month downtrend. This suggests a decline is due, especially considering the fundamentals we've already covered.
In light of this and other cyclical concerns, the Fibre looks a solid short at the moment. To protect against intensifying volatility, however, it may also be wise to consider a small gold allocation.
Sterling rues missed opportunities
Things are not quite as negative for the British pound, despite the island nation facing similar issues surrounding energy prices and inflation. Some supporting factors include the positive sentiment over the future of post-Brexit Britain and the extremely high vaccination rate of the population, making a fresh lockdown unlikely.
However, GBP/USD has already failed to capitalise on the mild bearish atmosphere around the dollar, continuing to slip lower as investors gear up for pivotal Bank of England (BoE) and the Federal Reserve policy meetings. If a rate hike is ultimately announced by the US regulator, it will put even more downward pressure on the Cable. This effect is only likely to be amplified by the continuing uncertainty over the Northern Ireland protocol, which makes sterling inherently less attractive to investors.
According to FX Strategists at UOB Group, GBP/USD could be heading for its local support of 1.3625 in the weeks ahead as capital flows out of risk assets into safe havens such as the US dollar and precious metals. Much will depend on the extent of the central bank tightening on both sides of the pond, but the downtrend can be expected to continue, so shorting the Cable or simply buying the US Dollar Index could be a smart move. Perhaps consider waiting until after Wednesday or at least have a tight Stop-Loss set.
Not much to separate USD /JPY
The domestic situation in Japan is relatively stable compared to the West. Japanese Prime Minister Kishida's Liberal Democratic Party has just easily retained its majority in parliament, and the country has no energy supply crisis to speak of. In the short term, the yen is down from its 8-day high of 114.44, but this is largely due to slumping US Treasury yields ahead of this critical Fed decision.
It's easy to forget that the greenback isn't actually doing that well at all in the grand scheme of things; it's just that its competitors in Europe and elsewhere in the world are faring much, much worse. The Japanese yen is an interesting case as — unlike the other majors — it's also considered a defensive currency. This means that any strengthening of the greenback in response to a more hawkish Fed policy will also be reflected in the yen. As such, any gains for the dollar will be effectively cancelled out or at least diminished.
Estimates for the pair would appear to corroborate this theory as no significant swing is expected over the long term. Trading Economics have USD/JPY trading at 114.48 by the end of this quarter, rising to 115.89 in 12 months. As we've seen, factors like central bank tightening and general global uncertainty mean the yen and USD are fairly correlated at present. While there isn't likely to be much upside on the yen that the US Dollar Index won't equal, it's always wise to diversify to mitigate any potential US-specific negative factors. It might be a good shout to keep half your dollar cash in yen just to be on the safe side.
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