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US Dollar Forecast to Decline as Markets Complacent

By , Quantitative Strategist
13 February 2012 16:00 GMT

The US Dollar showed early signs it could recover versus the Euro and Australian Dollar, but consistently low forex volatility expectations suggest the Dollar could hit further lows in the week ahead.

DailyFX Individual Currency Pair Conditions and Trading Strategy Bias

forex_us_dollar_forecast_market_volatility_body_Picture_1.png, US Dollar Forecast to Decline as Markets Complacent

DailyFX PLUS System Trading SignalsLast week we wrote that exceedingly low volatility expectations pointed to further US Dollar declines, and much the same could be said of this week. Such an outlook looked at risk last week when the safe-haven US currency staged somewhat of a comeback. In fact we wrote that Friday’s important bounce in the S&P 500 Volatility Index served as a clear warning to US Dollar bears.

Yet Monday has seen the USD once again lower, and a similar drop in volatility expectations leaves our previous bias largely intact. As we wrote last week, the safe-haven US currency will tend to do poorly if markets do not fear large exchange rate moves. Given domestic interest rates near zero percent, speculators most often prefer being short US Dollars and long higher-yielders amidst slow market moves.

We favor USD weakness against the Australian Dollar, Canadian Dollar, and New Zealand Dollar especially. These currencies will tend to do well in such times of market complacency.

Market Conditions:

Volatility expectations trade near their lowest levels since the onset of the financial crisis in 2008. Such extremely low levels favor slow trends and tight currency trading ranges until further notice.

forex_us_dollar_forecast_market_volatility_body_Picture_2.png, US Dollar Forecast to Decline as Markets Complacent

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To contact David, e-mail drodriguez@dailyfx.com

To be added to David’s e-mail distribution list for this and other reports, e-mail subject line “Distribution List” to drodriguez@dailyfx.com

Definitions

Volatility Percentile – The higher the number, the more likely we are to see strong movements in price. This number tells us where current implied volatility levels stand in relation to the past 90 days of trading. We have found that implied volatilities tend to remain very high or very low for extended periods of time. As such, it is helpful to know where the current implied volatility level stands in relation to its medium-term range.

Trend – This indicator measures trend intensity by telling us where price stands in relation to its 90 trading-day range. A very low number tells us that price is currently at or near monthly lows, while a higher number tells us that we are near the highs. A value at or near 50 percent tells us that we are at the middle of the currency pair’s monthly range.

Range High – 90-day closing high.

Range Low – 90-day closing low.

Last – Current market price.

Bias – Based on the above criteria, we assign the more likely profitable strategy for any given currency pair. A highly volatile currency pair (Volatility Percentile very high) suggests that we should look to use Breakout strategies. More moderate volatility levels and strong Trend values make Momentum trades more attractive, while the lowest Vol Percentile and Trend indicator figures make Range Trading the more attractive strategy.

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13 February 2012 16:00 GMT