Central banks take center stage

November 23, 2014 05:24 PM

As we head into the shortened holiday week, economic news is dominated by Central Bank policy decisions around the world and currency market activity provides great insight into what is really happening. The great recession of 2007 through 2009 may have been sparked by the subprime mortgage crisis in the United States but its effects have been global. The U.S. Federal Reserve took creative, swift action followed by very aggressive policies that included Quantitative Easing (QE). This approach, to a certain extent, is now being implemented by central banks around the world.

Because of the success of the Fed’s policies the U.S. economy looks to be on firm footing; giving the Fed room to begin implementing its exit strategy to return to normal policies. In contrast, the ECB, BOJ, BOE and PBOC are all dealing with worsening economic conditions, slow growth and the threat of deflation, and are being forced to act. QE or stimulus programs inject money into the system with the idea that there is more money to chase limited goods driving prices higher and creating economic growth. However, currency devaluation is also often a consequence.

Looking at currency rates between countries (cross rates) gives insight into buying power and economic strength. Since business cycles tend to take years to complete, trends in currency weakness or strength tend to last a long time as well. Currently the U.S. economy looks to be on firm footing and the Fed is in the very early stages of unwinding its stimulus program so it would make sense for the dollar to be strengthening against countries whose economies are stagnant or weakening. As we have seen repeatedly recently, mere hints by central banks about possibly starting stimulus programs can put pressure their currencies. Compared to the U.S. Fed, the BOJ and ECB find their economies on the other side of the business cycle; and they’ve begun to more aggressively stimulate their economies. Their currencies have devalued against the U.S. dollar as a result. The UK finds itself in middle with the economy on stable ground but fears about its proximity to Europe somewhat overshadowing the country’s recovery.

Below, see a monthly chart of the U.S. Dollar Index. The Dollar index is made up of a weighted basket of six currencies:  Euro 57.6%, yen 13.6%, pound 11.9%, Canadian dollar 9.1%, Swedish krona 4.2%, Swiss franc 3.6%. Since August 2014, a bullish trend has been developing, fueled by the growing economic stability that is allowing the Fed to begin stepping back with stimulus. I’m looking for a break of the 90.030 level to confirm the breakout to the upside with plenty of room to move to the upside. There are many other ways of trading these developments; the U.S. Dollar against all major individual currencies or other currencies against each other.

 

Source: www.tradingview.com [accessed 11/21/2014] 

Outlooks and opinions included are those of the author and not necessarily RCM

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