Talking Points:

- Today marks the end of Q2, and below, we look at three of the more interesting Forex themes from the first half of the year along with what to watch for in Q3.

- The final two weeks of Q2 have been rather active, as the Fed’s rate hike in mid-June was followed by the development of bullish themes in the Euro and Pound, while Japanese Yen weakness has begun to show prominently again.

- For trading ideas, please check out our Trading Guides. And if you’re looking for something more interactive in nature, please check out our DailyFX Live webinars.

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Today marks the last trading day of the second quarter, and 2017 has already been an active year. We’ve now seen two rate hikes from the Fed in 2017, tallying a total of three in the past seven months, and yet the Greenback is down -7.8% from the high set on January 3rd. We’ve also seen the rise of hope around European growth and inflation, and even the British Pound has begun to show strength as the BoE has started to get more hawkish.

Below, we’re looking at three of the most pressing price action themes for the Forex market as we walk into the 3rd quarter of this year. We had discussed these themes in yesterday’s webinar, and the archive is certainly available to anyone that would like a video accompaniment to this morning’s piece.

Dollar Weakness

Probably the most notable event so far in the FX market in 2017 has been the continued shelling in the U.S. Dollar. What initially started as a dip in a really strong trend as we moved into 2017 has turned into a back-breaking reversal, and perhaps surprisingly, this has all taken place while the Fed has been persistently hawkish. But – relativity matters, in both outer space and foreign exchange – and other major Central Banks have begun to show hawkish signals that have sent rate expectations moving-higher.

So, a considerable portion of this sell-off in the Greenback appears to be from no fault of the Fed or the U.S. economy; but rather the rising expectations around inflation being seen in Europe and the U.K. Given that these are both rather new developments in longer-term sagas, there is considerable continuation potential should the drivers of these themes (sentiment, inflation) continue to move-higher.

The most difficult aspect of expecting continuation of the move is the fact that the U.S. Dollar opens the quarter on an incredibly weak foot. At this stage, we’ve retraced the entirety of the post-Presidential Election run, and we’ve even broken-below the bearish channel that’s denominated price action in the Greenback so far this year. So, while USD-weakness remains a favored theme as we move into the new quarter, price levels are of concern, and traders will likely want to wait for a pull-back in the bearish move before looking to press bearish exposure too heavily.

Full-Stop Reversal in the Greenback (Red Vertical Line Marks Final Trading Day of 2016)

Top Three Price Action Themes for the Forex Market in Q3

Chart prepared by James Stanley

As we discussed yesterday, and on that topic of relatively, the currency that could continue be attractive for bullish-USD plays is the Japanese Yen. Japanese inflation continues to lag and, logically, the BoJ will probably be one of the last Central Banks to move away from stimulus; so the Yen could remain favored as a funding currency, even against what has been an incredibly weak the U.S. Dollar.

Euro Strength

The second quarter saw the theme of Euro strength become a very real variable. While the first quarter could easily have been qualified as a retracement in the bigger picture bearish move, Q2 saw the resolution of French elections, and this appeared to remove a wet blanket of offers as the single currency popped-higher after the first round of elections and has pretty much kept running-higher ever since. There was even a weekend gap around the first round of French elections that remains unfilled from 1.0738-1.0821, and we’re currently around ~600 pips higher.

Since that first round of French elections, we’ve had two ECB meetings which saw the bank remain rather dovish. Markets, however, appear to be trying to get in-front of an inevitable stimulus exit, as the dovish outlay at each of those ECB meetings merely elicited a revisit of support that held until Euro bulls came back to the party to bid the currency-higher.

The Euro appears overbought against the Greenback after this week’s speech from Mario Draghi sent the currency jumping-higher. We’ve seen a top-side breakout of a bullish channel, and EUR/USD looks to be off to the races. So, while the bullish trend remains very attractive here, it is notable that the Euro looks to be rather stretched as we walk into the second half of the year. On the chart below, we’re looking at this bullish structure, and we’ve added three nearby support levels that can be used for continuation approaches in the first few weeks of Q3.

EUR/USD Bullish Breakout of Bullish Channel, Near-Term Support Levels Applied

Top Three Price Action Themes for the Forex Market in Q3

Chart prepared by James Stanley

Pound Strength on a More Hawkish BoE

The prospect of rising inflation in the U.K. has been somewhat of the elephant in the room since the Brexit referendum. After the ‘sharp repricing’ in the value of the British Pound around Brexit, it seemed rather logical that prices would rise as importers adjust in the attempt of protecting their margins. This relationship is rarely fast, and as we’re now a year away from the referendum, we’ve seen inflation in the U.K. running right up to 2.9%; almost a full 50% more elevated than the Bank of England’s own inflation target.

But – the Bank of England remained rather dovish in the post-Brexit backdrop: It wasn’t until March that we saw a single vote within the MPC dissent for a rate hike, and then in June we saw an additional two votes to produce a 5-3 split. Sterling continued to see sellers at resistance as this very much looked to be a ‘transitory’ theme, but this got very real earlier this week when BoE Governor Mark Carney warned that the U.K. may need to hike rates. This now gives the appearance that there is a concerted shift at the Bank of England that may continue to see the bank grow more hawkish and, eventually, this could produce a rate hike.

The big item on the calendar for Q3 in the British Pound is the Bank of England’s Super Thursday event in August. This is when we’ll get updated inflation forecasts from the bank, and this would be an opportune time to signal any potential tightening of policy that might be seen in the months ahead. The major area to watch on the Cable chart is the 1.3000 psychological level, as the pair has had an incredibly difficult time overtaking this level since the ‘flash crash’ in October of last year. This week’s bullish reversal has sent price action screaming right back to this level. Sellers have been able to hold resistance at 1.3000, at least so far, but if prices do rally above this level, bullish continuation can remain a very attractive theme as we move deeper into 2017.

GBP/USD Daily Chart, Horizontal Line Applied at Psychologically Important 1.3000 Level

Top Three Price Action Themes for the Forex Market in Q3

Chart prepared by James Stanley

--- Written by James Stanley, Strategist for DailyFX.com

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