Fundamentals – Signals of US Recovery Confuse Forex Market


18:12 GMT - Although my forex signals are 95% technically-based, like any good trader I also keep an eye on the underlying fundamentals as well. My philosophy is that the fundamentals will provide the trade direction while technical analysis will give you the specific entry and exit points. To that effect, I've talked a lot recently about some of the risk-aversion that is driving the market. Under normal market conditions investors want the highest return on their investment, and that means investing in a currency that has the higher interest rate or other, more risky investments such as stocks.

In the past few months, however, we've seen the dollar gain against currencies with higher interest rates, defying normal fundamental expectations. So what gives? The answer is Risk Aversion. Risk Aversion is when investors take money out of possibly riskier investments (e.g. stocks or developing countries) and put them into safer vehicles (such as the US Dollar). This is why recently we've seen the US Dollar do the opposite of US stocks - when stocks go up, the dollar went down; when stocks turn south  the dollar rallies.

But with fundamental news coming out that signals a semi-recovery of the US economy, why aren't higher-yielding currencies a no-holds barred freight train against the low-yielding dollar?

Well, the dollar has lost some ground this week on news of better home sales, increased consumer confidence etc., but it certainly hasn't plummeted.  I came across this excerpt this morning which pretty accurately explains the fundamental picture of the market right now:

"With trading volume light, analysts said differing views about how to trade strong U.S. economic data was causing the odd price action, with some seeing it as a signal to buy risky assets and others expecting it to lead to a U.S. recovery and higher interest rates, increasing the dollar's appeal.

"This push and pull of two different viewpoints is why you're seeing this ambivalence in the currency market," said Samarjit Shankar, managing director of global FX strategy at BNY Mellon in Boston. "There are those who think the dollar just might be supported on the back of a U.S. recovery."

So the short answer is their are two schools of thought on what is the safer/higher returning investment in the short and mid-term. And some people further aren't convinced the news out of the US is all that great considering much of the recovery to date has been because the US government has printed money to help itself and that can't last forever.

Expect more volatility in the months to come, which means range trading with an eye toward further USD losses.

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