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22/10/2014: With volatility calming down in Europe, forex markets are on a knife edge


After the high volatility of the past couple of weeks, finally some calm is settling on the markets. European equity indices are all but flat and sovereign bond yields are fairly restrained, as the market’s gauge for volatility, the VIX Index, continues to fall. However, after all that has gone before and knowing what we have got ahead of us, the chances are that this morning is merely a brief respite before the next bout of volatility hits the market.

Forex markets remain choppy, seemingly throwing out a series of mixed signals all over the place. I was caught yesterday starting to believe that the dollar was beginning to suffer. However a turnaround in the second half of the day put that theory to bed pretty quickly. The truth is that forex markets are going through an uncertain phase of trading, looking for the next trend. In this scenario we need to have confirmation of any signals before moving with conviction. The charts are littered with false signals and it is easy to make mistakes trading in front of confirmation.

The euro is a good example. A nice higher low posted around $1.2600, but with a recovery building nicely, near term support at $1.2700 has today been breached. This leaves EUR/USD with a very difficult outlook to decipher. I have seen $1.2700 as a near term watershed, but having breached this support level this morning, the euro is currently trading around $1.2700. The rebound for the dollar in the past 24 hours has turned sentiment on its head again and I am concerned that there will be a test of $1.2600 again, however the break of $1.2700 has not been clean and could once more be a false signal.

The move lower in the euro was driven by the reports that the ECB was readying a programme of corporate bond purchases within the Eurozone, although this has since been denied. This morning also there are reports that 11 out of the 600 banks are set to fail the Asset Quality Review stress tests (results announced on Sunday), although again unconfirmed.

Cable is another major that has suffered in its outlook over the past 24 hours. Yesterday with the resistance of the downtrend creaking under the strain of a sterling rally a sharp turnaround has seen $1.6080 support breached this morning. The release of the Bank of England meeting minutes was largely as expected at 7-2 in favour of keeping interest rates flat. However, the suggestion that the outlook for inflation gives little justification for a rate hike has given the market the excuse to hit sterling again. Despite this the key near term support has held around $1.6020 today and the outlook is mixed once more. 

Cable   22102014

Also add into the mix, the fact that Dollar/Yen has gone basically no where in the past 3 days around 107.00, but has struggled at 107.50 resistance and left 106.22 support. Technical indicators are all but neutral now too.

This all suggests that the major forex pairs are waiting for the next big catalyst. This could come with US CPI inflation this afternoon. The expectation for the release at 13:30BST is for a slight dip to 1.6% (from 1.7%). Any miss of this data (UK inflation missed by 0.2% last week) and this could put big pressure back on the dollar once more. The Dollar Index (.DXY) is still in its downtrend channel.

DXY   22102014

The big question is whether this downtrend channel over the past few weeks is the beginning of a longer corrective phase, or turns out to be some sort of falling wedge/flag formation. If the dollar continues to rally from here, the bulls could be hard to suppress, especially if the Dollar Index breaks above 86.01 resistance (currently at 85.52). Note also though that the 21 day moving average having been a basis of support could also now be a basis of resistance at 85.54.

There are some significant data releases that could impact the situation, with US inflation just the beginning. The flash PMIs throughout tomorrow (China, Germany and the US) could hold huge sway on how the dollar performs in the next few days. That is also not to mention the US New Home Sales (Friday) and the results of the ECB’s Asset Quality Review on Sunday.

This all suggests that forex markets are on a knife edge at the moment and they could easily tip either way. This morning’s price action could just prove to be the calm before the storm.


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