Caution Needed in the FX Markets

Caution is the watchword for the FX markets. Major directional moves appear to occur at the drop of a hat. Whilst those day trading love the volatility, the longer term players certainly do not. At the moment, dealers seem unhappy about putting too much into any individual positions.

Looking at the key Euro/Dollar cross rate, the Euro has gained heavily from US weakness in the last month or so. Market pull backs are just being seen as better buying opportunities. Overall, the forex spread trading market is still heavily short of the Euro and this is forming a natural support as each rally is seeing its own mini short-position-squeeze.

The markets have temporarily ignored the obvious debt risk around Europe and have been concentrating on the poor data emerging from America. The US Dollar has continued to weaken and it looks like the Euro has managed to get a foothold above $1.26 level for the first time since early May 2010. However, it is only a foothold and could easily give way in the current climate.

Although the FX markets remain Dollar negative it does look like Sterling is struggling to maintain the bullish trend. Unlike the Yen and the Euro, the Pound has gained no new impetus from all of the poor data coming out on the other site of the Atlantic. Traders should beware of any nervousness creeping into the Sterling/Dollar pair.

Looking in more detail at the Sterling/Dollar pair, according to Simon Denham of Financial Spread, “$1.52 seems to have had an irresistible attraction for the markets over the last 18 months or so. No matter how far the exchange rate falls or rallies we seem to eventually get back the $1.52 mark.

“We are also close to a crucial trend level as well with the two year bear-trend line at $1.5350 and the bulls will be aiming for this. If the news remains UK-positive, a break here may well give the Pound a sharp kick higher”.

Unfortunately there is always the other side of the coin and the UK economy is in a poor state to say the least. This is especially true as most of the solutions are still in the future. On top of this, UK growth is fragile and unlikely to be helped much by the Eurozone in the medium term. Once we take into account that the markets are easily spooked at the moment, and that there will be some weak data coming out of the UK, any upward trend is likely to be of the stop-start variety. It looks like caution will remain the watchword for some time yet.