With the Worst Behind Us, There is More Ahead

Since the Fed's tectonic shift on June 19th investors have been left stunned but directionless by the Fed's ambiguity.

Since the Fed's 19th June FOMC meeting and consequent overshoot in many financial markets, the Fed has wheeled out a raft of commentary to try to talk the markets down (bond yields and USD) or up (equities, bonds and commodities). Clearly, both the Fed and the U.S. authorities have disliked the sharply risk-averse market reaction to the FOMC announcement and Bernanke's June 19th Q&A. As they say in trading circles, 'markets go up like a staircase but come down like an elevator'. This trading axiom is best illustrated in equity indices worlwide, commodity currencies and precious metals respectively. After many months of slowly appreciating equities, bond, commodities and risk-FX, all those gains were wiped out within days/weeks of sharp USD demand and commodity sell-offs.



The Fed commentary being put out since June 19th is very dovish and indicates the Fed's likely continuation with asset purchases/QE. The dovish rhetoric is likely to permeate the markets this week and help all currencies recover some losses against USD. The currencies with largest upsides are AUD, NZD and CAD. Gold prices could also see a healthy bounce considering the rate of decline seen in all precious metals over the past month (largely due to hawkish Fed expectations). Although we've seen some retracements last week, we should see further extensions of risk-friendly market moves i.e. USD weakness, bond strength, commodity strength and equity market strength as investors re-join the ZIRP gravy train.




Looking at how investors are positioned at the start of this week, it’s clear that the majority of the market remains USD positive. In EUR/USD & GBP/USD investors are 50-50 long/short, in Gold 65% are short while in USD/JPY 75% are long. However, we may see a change of sentiment in the FX market this week because dovish Fed policy has most likely been "misoverstood" by market participants (as evidenced by dovish Fed speak from Fischer, Dudley, Powell and Lockhart last Friday). The most volatile and thus risky way of backing such a view is by looking to take long positions on Gold, Silver and other precious metals.

The Fed's traditional dove/hawk stances should help traders as they listen out for further Fed speak this coming week. Bear in mind, that the all-important U.S. unemployment report is due this Friday and will be watched by all market participants as a possible catalyst for upcoming Fed policy. The Fed has repeatedly stated its intention of gauging U.S. employment, inflation and growth as the key indicators in deciding whether to remove or add QE so this Friday's non-farm payrolls are likely to cause even more event risk and market volatility than usual. With the market expecting circa 160,000 jobs to have been added to the U.S. economy in June, event risk is high. Expect USD demand to increase if we see a significantly strong print >200,000. On the other hand, a print below 120,000 would initially be seen as negative for the U.S. economy but better in terms of QE expectations and a better U.S. economy! (counter-intuitive) thus leading to higher equities, bonds, commodities - but a weaker USD. Tin hats will be required this coming Friday so we expect large parts of the trading community to stay away from trading the headline figure, and focus on the aftermath instead.

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Commissioned by Think Forex

Written by George Tchetvertakov

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