Is It Time for a USD Correction?


As those who watch the FX markets know all too well, whilst currencies have a tendency to trend, they seldom do so in a straight line. Corrections occur for many reasons. It could be that market positioning becomes so concentrated that there are simply not enough buyers left in the market to continue to push the pair higher, or it could be that the strength of the US data that has underpinned the move higher has created very high expectations for future data, and disappointment is inevitable. Whatever the reason for a currency pair to stall and then start to move lower, market psychology kicks in and can sometimes create quite a sharp corrective sell-off.

 

 

The corrective waves (2 and 4) tend to occur when market participants become largely aligned in their view that the markets will continue to advance, and therefore participants have been actively buying the currency in question. This can be clearly seen of late by the Relative Strength Index (RSI), which measures is a momentum indicator that measures the speed of changes in price. The RSI’s for both EURUSD and GBPUSD are at or near extreme lows, where corrections tend to follow.

 

Chart 2: EURUSD RSI

 

Chart 3: GBPUSD RSI

 

Corrections also tend to occur when expectations for the strength of data from a particular country become extremely positive (as was the current case in then US) or negative (as is the case in the UK and Eurozone). When data continually exceeds expectations, the expectations for future data become higher, and eventually it is inevitable that the actual data will disappoint. Currency moves tend to lag the data as market tends to ignore the first few disappointing data releases as anomalies. This can be seen in the Data Surprise Indices below.

 

Chart 4: US Data Surprise Index (the bloom has come off the rose)

 

 

Chart 5: Eurozone Data Surprise Index (things are looking up)

 

 

Chart 6: UK Data Surprise Index (looking somewhat better)

 

 

Looking at these charts through the eyes of a technical analyst, it seems clear that the markets will do one of two things in the short run; either 1) trade sideways for a time while those who are losing faith in the dollar’s recent strength supply USD to those still expecting a continuation of the April/May rally, or 2) the USD will experience a short, sharp sell-off as those who came late to the party start to lose money on their long dollar positions and start to dump their dollars.

Regardless, of whether we see a period of consolidation, or a selloff to levels of a month ago, our core view is unchanged; we continue to expect US Dollar strength in the coming quarters.

 

Author: John Glover



 

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