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Outlook for the majors in a troubled world

In the post-Brexit environment, the Forex market is characterized by sudden bursts of volatility and erratic price behavior. We’re obviously going through a transitional period with exceptionally volatile markets in the aftermath of Brexit, the European migrant crisis, Turkey’s failed coup, troubled Middle East, ISIS, multiple terrorist attacks engulfing Europe, and upcoming US elections. These are all risk events that in one way or the other will affect the long-term outlook of the major currency pairs. Together they represent a potential tipping point for much more systemic moves; a considerable risk to the stability of the financial system.

The Brexit does carry through into the future and it’s going to carry significant influence on the next moves of the British Pound, the Euro and significantly, the US Dollar. It could prove to be the ultimate motivator for a general shift in risk appetite trends. Slowly but consistently the focus is shifting from these big risk themes and now the markets, at least in the short-term, are being driven again by the Central bank’s relative monetary policy.

The GBP/USD outlook remains bearish. Not only do the fundamentals suggest so, but broad-based dollar strength and the greenback bullish cycle points to more GBP/USD downside pressure. The technical GBP/USD pattern post-Brexit meltdown (see Figure 1) indicates a new low to follow, accompanied by infrequent sharp rallies, reaching a final target of parity.

Figure 1: GBP/USD Monthly Chart
Figure 1: GBP/USD Monthly Chart

Brexit will have a much bigger impact in the long-term on the EUR/USD. It implicitly threatens the survival of the 28-nation bloc, at least in its present form. This most likely will be the catalyst for the resumption of the bearish trend started since the summer of 2014. Ultimately, the ECB will be forced to boost its stimulus efforts as the actual Brexit process starts, which will exacerbate the gap in the interest rate differential which could drive EUR/USD to parity and beyond (see Figure 2).

Figure 2: EUR/USD Monthly Chart
Figure 2: EUR/USD Monthly Chart

There is no significant evidence suggesting that the US election cycle has any material effect on the US Dollar in terms of whether the Democrat candidate or the Republican candidate will win. Irrespective of which candidate will win the impact of the US election on the US Dollar is the same and the greenback seasonal tendency is to strengthen (see Figure 3).

Many financial pundits are calling for a Dollar crash in the event that Donald Trump triumphs. This view is not anchored in reality as there are other bigger forces behind movements in the FX market.

Figure 3: US Dollar Index Election Years – Seasonal Pattern
Figure 3: US Dollar Index Election Years – Seasonal Pattern

The efforts of the US Federal Reserve to be more transparent are in practice quite vague. As a result, we can’t really get a good sense of the exact timing of the next rate hike. On the other hand, we have the markets, which continue to discount the chance of any rate hike this year. This uncertainty will make investors continue guessing when the Fed’s normalization cycle will resume which in turn will be the catalyst for more FX volatility, which ultimately means more trading opportunities ahead of us.

 

 

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