Currencies: Just ignore the news and trade
FX pairs have whipsawed on the latest headlines about statements from the President and his Treasury appointee on the strong US dollar. Zoom out, however, and it's clear that whether you are bullish or bearish, you may not want to ignore the underlying trend.
By Vikram Rangala
Monday, January 23, 2017 - 00:00
Except for some notable outliers like the Canadian dollar, most major currencies have risen against the US dollar, which spent the latter half of December hovering in a sideways channel near its highest level since 2003. At the end of 2016, the dollar broke out of that channel in both directions—first down, then up—before losing roughly 2 percent in two days.
Since that drop, the US dollar has continued downwards, though it remains strong. At the same time, the euro, yen, and particularly the Australian dollar have all surged versus the USD, reaching new 2017 highs last week. The British pound had suffered a couple of sharp drops in early January, but then rallied dramatically on January 17th.
It was on that day that Prime Minister Theresa May announced that parliament would finally vote on the UK's exit from the European Union. That ended months of speculation and worry about a Brexit that could be messy and poorly managed. Instead, investors heard a clear statement, if not a detailed plan, about a "hard" Brexit that would separate Britain from the EU and allow firms on both sides to move forward.
That sort of rally, on definite statements about actual legislation, makes perfect sense. While the GBP has had the choppiest January of the major currencies, it has also been the most logical in its behavior. It dipped prior to the Brexit announcement, then made its biggest one-day rise since October 2008 when the situatlon found clarity.
The ups and downs of the USD over the last few days are not as logical, since they appear to be reactions to an off-the-cuff statement by President Trump on the one hand, and a vague statement by Treasury Secretary nominee Steven Mnuchin on the other.
Specifically, President Trump gave an extensive interview to The Wall Street Journal last week in which he was asked about US trade with China. China has long had a policy of holding down the value of its currency, the yuan, by buying dollars.
How does that work? To put it very simply: demand for anything tends to raise its value. So when China exports a lot of goods to the US, it raises the value of the yuan. The problem with that is, when the yuan becomes more valuable, Chinese goods aren't as cheap to buy and the demand for them goes down. China needs to keep both its currency and thereby its manufactured goods cheap.
The same demand effect works on currencies. If demand for US dollars is high, it raises the value of the dollar. With all the uncertainty in the economies of Europe, Japan, and the UK in recent years, the dollar has been the safest currency and in high demand. That's why it's so "strong".
To help keep the US dollar strong, China buys US dollars on the foreign exchange market, driving up demand and keeping the US currency strong relative to the yuan. The US buys China's stuff; China buys US money.
It was in answer to that question that President Trump said, “Our companies can’t compete with [China] now because our currency is too strong. And it’s killing us." It's nothing people don't already know and most economists agree that the President can only do so much to weaken the dollar if he wants to. But some investors still reacted to that little remark.
A few days later, during his confirmation hearing before the US Senate, Treasury nominee Mnuchin said sort of the opposite of what his boss said. He said that the long-term strength of the US dollar is important. It may be the least surprising thing a prospective Treasury Secretary can say. It's like the Defense Secretary saying ships are important to the Navy.
Nevertheless, some traders reacted as though it was a shocker. No doubt some traders who bought or sold based on these statements made money, but if your timing was off, you could just as easily have missed. Meanwhile, the true picture is pretty clear, as you can see in this chart of the AUD/USD pair.
That's clearly an uptrend. That doesn't automatically mean you should only go long. At Nadex we never make trade recommendations, but even if we did, there's more than one way to trade this market, particularly with short-term binary options and spreads. Those sharp dips and downturns that punctuate the longer uptrend could make great opportunities to sell. Just as the short-term upswings would make good buying opportunities.
The reason to keep aware of the bigger trend is so that you have context. Knowing that you're shorting a down move in a larger uptrend helps you avoid staying in the trade for too long and having it reverse back up and erase your gains. In the same way, you can buy a dip with greater confidence knowing that the overall direction of the market is up. You could, for example, just choose a later expiration time for your binary option to give the market time to resume its uptrend.
None of this strategy requires you to speculate on what a comment or tweet might mean for the future of the US dollar. US strong dollar policy has been in place for two decades at least and changing it will be like turning a supertanker: slow and gradual. In the meantime, it makes more sense to trade what is actually happening instead of what might happen.
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