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Upward EURUSD Momentum, Dollar Index Weakness, and New Trends for MXN

Posted on: 02 February 2018 , by: Darren Sinden , category: Market Review

This week's three key trade setups: Eurodollar, Dollar Index and Mexican Peso

1. Trending: Long EURUSD

This is a trending idea in two senses: Firstly the Euro has appreciated against the US Dollar across seven metrics, ranging from daily all the way out to a 12-month duration. We can see this from the performance snapshot below.  

Euro percentage change versus the USD

Daily changeWeekly performance1-month performance3-month performance6-month performanceYTD performance12-month performance

+0.29%

+0.97%

+3.44%

+6.53%

+5.28%

+3.44%

+17.88%

The ongoing upward momentum has created significant trend support that dates back to the mid-April 2017 lows of $1.0570. The uptrend line drawn from that point has rarely been tested and when it was, back at the very end of 2017, the 200 day EMA line acted as additional support.    

 

EURUSD as of 29-01-2018

The more sensitive 20 and 50-day lines have also offered support in recent weeks. Both have been moving higher, as has the 200-day variant. Meanwhile, the Euro is at or close to being overbought on an RSI 14 basis, over both daily and weekly time frames. The readings for  H1 and H4 timescales are currently below the 70 level. What's more, on these timescales RSI 14  has a history of extending into the low to mid-80s, before correcting lower. There is no reason to think that this short-term momentum could not show its hand again. 

Secondly, long EuroDollar is also trending or becoming more popular among large speculators, according to Data from the US CFTC Commitment of Traders or CoT report. 

It showed that the group had added more than 5200 contracts, or lots, to their long positions in the week ending the 29th of January. That positioning has been growing steadily over the last three months or so. While in the Margin FX space, Pepperstone’s sentiment indicator shows that retail clients are opposing the Euros rally, with 64% of reporting clients short the pair. That leaves the door open to a possible short squeeze if EUR USD takes out $1.2538 the Jan 25th high and $1.2570 the early December 2014 high. 

2. Contrarian: Long Dollar Index Opposing the crowd

The trade-weighted US Dollar is down by some -10.77% over the last 12 months, and it has been among the most out of favour investments on the planet over this period. Since the New year, the index has traded below 90, a key psychological level because of its round number value. Having broken below 90, Dollar index posted a low of 88.4380 on January 25th, and it has since failed in its bid to move firmly back to the upside. But maybe now is the time to think again about Dollar Index and to consider a contrarian position. After all, markets are by their very nature cyclical. From a positioning standpoint, recent COT data shows that short positions in Dollar index have been declining. As we can see in the chart below, it almost halved from their June 2017 peaks.

 

Declining Short Positions in Dollar Index

More recently weakness in Dollar Index has been associated with rising bond yields which have quite literally exploded. Indeed the yield or effective interest rate on the US Two year Treasury note, has risen by approximately 175%, since September last year. The kind of move that is almost unheard of outside of economic or financial crisis. That sharp move higher has been driven by expectations of rising US interest rates and an end to QE, on the part of the ECB and ultimately the BOJ. Such has been the ascent in Two Year yields that the RSI is now well above 80 and therefore at levels that we have only seen twice before over the last forty years. On that basis, it seems unlikely therefore that the bond sell-off, Yield rally,  can continue at that pace. Any pullback or decline in yields should equate to a bounce in the Dollar index. And who knows the market may even remember that rising interest rates should be currency positive, in a low inflation environment. As they increase the real returns that investors receive. Taking a contrarian or opposing position is never an easy thing to do, but if the timing is correct, then it can be a profitable one.

3. Signal - New bear trends in the Mexican Peso

For our signal idea, I thought we would look at the Mexican Peso, a North American currency that is often overlooked in favour of the US and Canadian Dollars. Mexico is often thought to be a commodity-linked economy, and it's true that both Silver and Oil and Gas reserves are important to the country. But the trading relationship with its larger neighbour to the north is crucial to Mexico. As we noted in the trader's guide to Commodity Pairs some 81% of the countries exports cross the border to the USA. President Trump is currently attempting to re-negotiate the North American Free Trade Agreement or NAFTA, that defines this relationship and not in Mexico's favour. In the past week, the medium term FX model I follow has signalled new bear trends in both the Mexican Peso and the wider Latin American Dollar Index, a trade-weighted basket of Latam currencies, of which the Mexican Peso makes up 33% (the Brazilian real enjoys a similar weighting in the basket). A weaker currency should, in theory, be good news for the countries exporters. But only as long as they enjoy unfettered access to the USA for goods such as Autos, Parts and Computers. Without that easy access, things could look very different indeed. The Peso has moved higher short-term but appears to struggle at the 200 day EMA line circa 18.7850, which could be an attractive entry point for a sale.

 

 

MXN Chart 20-01-2018 - 17.15 to the Dollar is possible

Regarding downside potential, the model suggests that 17.15 to the Dollar is possible - A level last seen in late April 2016. before that, however, 17.50, a low from mid-July 2017 appears to be attainable. With the Trump administration talking tough over trade once more and ongoing NAFTA negotiations proving to be inconclusive. There is plenty of uncertainty to concern investors. Bankers HSBC has suggested that were NAFTA to break up completely, admittedly a worst case scenario, then the Peso could fall by as much as -15% against the US currency, so it is certainly one to watch.

 

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