The U.S. dollar was decimated during the summer and early fall of 2010 as traders sold the greenback based on the expectation that the Federal Reserve was going to move forward with a second round of quantitative easing. Sure enough, in early November, the Federal Reserve officially announced that it would indeed move forward with further asset purchases to the tune of $600 billion over next 8 months.
From June to October, market participants were pricing the Fed’s move into the U.S. dollar, and, therefore, the dollar fell sharply.
Then, QE was finally announced in early November, and the market immediately sold U.S. dollars aggressively as EUR/USD reached multi-month HI’s at 1.4260. However, shortly after the announcement in early November, the dollar finally found a bottom, and began to move sideways into the end of the year.
This sideways market in the US Dollar Index carried over into the currency trading as the EUR/USD moved in a 400 pip range throughout the month of December. Currently, in early January, price has put pressure on both the top side and bottom side of this range, but buyers and sellers have both failed to push price outside this range and gain an upper hand.
Now that we are into 2011, price will most likely break out of this range very soon. The question is, which way will it go? Currently, the global economy is continuing to show signs of unrest. First of all, sovereign debt concerns in the EuroZone are not going away. Much of the dollar strength that we saw in the month of November was a direct result of the Irish bailout. Currently, we are two months past the Irish bailout, but Ireland is still in the headlines. During the first week of January, yield spread between Irish and German debt skyrocketed, which means that investors are still very wary of the situation in Ireland. These concerns are not good for the EuroZone because there are several other countries that are facing similar challenges including Portugal, Belgium, Italy, and Spain.
Global Currency War
Tensions are also continuing to build between developed nations and emerging markets. The extremely low interest rates in developing nations is causing liquidity to flow into emerging markets because investors are taking advantage of the higher interest rates in emerging market economies. This increased liquidity is driving up asset prices, exchange rates, and interest rates, and this conflict is a threat against global stability.
In the first week of January, China stated that inflationary threats are still very strong in its economy, and it placed most of the blame on developed nations, including the United States. This ongoing conflict could result in ever-increasing instability in the currency market if government begins intervening aggressively, and this could eventually cause a massive bout of risk aversion, which would cause the U.S. dollar to appreciate strongly. Fx brokers often offer free charting packages to track these dollar moves.
Altogether, it looks like fundamental pressure will be put on risk assets in 2011, and this could be very beneficial to the U.S. dollar. Even as the Federal Reserve continues to print massive amounts of dollars, market participants may deem that a second-hand thought when they face the need for safety and quality.
