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FX Technical Analysis (2016-10-17)

by James Chen

Fundamental Recap: Euro, Dollar and Gold in Focus Ahead of Key Risk Events

Markets have made some significant swings recently as several current and near-future risk conditions have heavily impacted investor sentiment. Going forward, the next few weeks promise to be rife with potential risk and uncertainty that could move markets substantially, particularly with respect to the euro, the US dollar, and gold.

First up is the euro, which has broken down sharply against the US dollar in the past week. This plunge for EUR/USD was largely due to increased dollar strength, but weakness in the euro stemming from the European Central Bank’s (ECB) quantitative easing programs and increasingly loose monetary policy have also played a role. Early last week, EUR/USD made a dramatic plunge below a trading range that had been in place for the prior two months, and currently continues to be pressured. On Thursday of this week, the ECB will hold its long-awaited October policy meeting and press conference. Any dovish pronouncements from the central bank as it continues or furthers its substantial quantitative easing measures could lead to significantly further downside for the euro, especially against the Fed-driven strength of the dollar.

Shifting to the US dollar and gold, support continues to mount for a US Federal Reserve interest rate hike by the end of the year. Wednesday’s minutes from September’s FOMC meeting showed that an unusually divided Fed still had some concerns about job growth and inflation, but that it looks to be getting much closer to raising rates, especially in light of several key Fed members warning that further delays in raising rates could be risky, potentially leading the economy into recession.

Adding onto expectations of an impending rate hike have been a parade of Fed speakers in recent weeks, both voting and non-voting members, who have largely made hawkish comments in favor of raising rates sooner rather than later, even despite September’s modestly weaker-than-expected, but still solid, US jobs report. Economic data on Friday in the form of US retail sales and the Producer Price Index inflation measure met or exceeded expectations, providing even further support for raising interest rates. While a November rate hike may still be off the table due to the event risk of the US presidential election occurring just a few days after the November Fed meeting, a December move by the Fed is currently seen as highly likely. The market-viewed probability of such a hike has remained high – well over 60% and approaching 70%.

These increased expectations for a December rate hike in recent days and weeks have helped to boost the US dollar significantly while weighing heavily on gold prices. The dollar has been rallying sharply since the beginning of the month, as gold has plunged just as sharply in the same time frame. Just as the dollar should benefit from any rise in rates, gold should continue to have a substantially negative reaction, as its non-yielding investment appeal diminishes in the midst of higher interest rates. Currently, gold sits right around the key $1250 support level after its recent plunge. With expectations of Fed action on the rise, gold prices could potentially have significantly further to fall.

Finally, a word about the upcoming US presidential election, just around the corner at a little more than three weeks from now. The election has been seen for several months as a substantial risk event for the markets, largely due to the prospect of a victory by the increasingly unpredictable and controversial candidate, Donald Trump. Developments in the past few weeks, however, have diminished this risk considerably, as his opponent, Hillary Clinton, continues to widen her lead over Trump. This has been due primarily to scandalous revelations and divisions in the Republican Party that have severely damaged Trump’s campaign, both with many of his previous supporters as well as the nation at large. With that being said, however, much could still change in this historic and volatility-inducing run-up to election day in early November, and the markets will likely continue to be wary until the final outcome is known.

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