The Fed Blinks: Dollar Finally Corrects While Stocks Fall

by Alexander Chepurko

EUR/USD H4, 9 October 2014

EUR/USD H4, 9 October 2014

The US Dollar has been on a roll for the past 5 months, each month making higher highs. Our call for a lower EUR/USD and a higher USD/JPY has seen quite generous outcomes but nothing is forever in the forex markets. We believe that now is the time for a correction in the EUR/USD downtrend, as well as in the USD/JPY uptrend. The CFD market is additionally showing signs of exhaustion as the S&P 500 Index trades at new lows for a second month.

What's causing the reversal?

Many traders probably want to rationalize why the trends in the forex market are reversing, Fundamentally speaking, various US central bank officials have been coming out and tamping expectations for the Fed to raise rates in the near future.

*It would be inappropriate to raise rates in 2015.

Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis

Even though economic indicators have been showing steady improvement, the Fed is still worried about falling inflation expectations.

Additionally, yields on the US 30-Year Treasury Bond have pulled back near lows of 3% not seen since August. The bond market is telling us that it doesn't believe that the Fed will ever hike rates above 3%.

The Trade

The first chart we will look at is of the EUR/USD, where the pair has broken out of resistance at 1.2660 and is now likely to test 1.2740. But we believe that a healthy correction will require EUR/USD to test higher, at around 1.2815 which is a former support level.

Moving on to USD/JPY, there is actually not much support between 108 and 107. We view 108 as a point of control, meaning that this is a pivot level where USD/JPY will trade frequently, and will be at the center of a range. Our view is that it is somewhat difficult to short the USD/JPY into 107 because of it's relative strength, and the more prudent approach would be to buy into dips towards the 107 level.

Remember this key point: the markets are probably entering a phase of correction, meaning that it is a temporary move against the overall trend. In the long term these corrections will serve to re-enter into the overall direction of the trend.

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