Talking Points:

- This week’s economic docket is a bit lighter than the previous few weeks, and this makes for an interesting backdrop in which trends can substantiate themselves as we move deeper into Q4.

- Of particular interest at this early stage of the quarter is the potential for a larger recovery in the U.S. Dollar. USD is working off of a key area of resistance; will bulls show-up at higher-lows for another re-test?

- DailyFX Q4 Forecasts have just been released – Click Here for Full Access.

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This week’s economic docket is relatively light, especially when compared to the outlays of the past few weeks. This can be an opportune time for trends to substantiate as we move deeper into the fourth quarter of the year, and with a heavy tonality of Central Banker-speak on the wires this week, the potential for such drive certainly exists.

My colleague Christopher Vecchio previewed this week’s data earlier this morning, and that’s available in the article entitled, FX Markets Eye Commentary from BoJ and Fed; US Data in Focus. In this article, we’re going to look at three markets of particular interest as some of the more pressing themes currently showing in the FX market.

Dollar Turn or Dollar Burn?

Last week saw USD-strength continue into a very key zone of resistance that runs from 94.08-94.30. This was the fourth consecutive week with the U.S. Dollar gaining value, and this is significant because that’s the first time that’s happened since February-March of this year, before the Fed began talking about balance sheet reduction.

As that topic of balance sheet reduction took over, markets grew skeptical that the Fed would be able to hike rates again this year. If the Fed is shifting their focus to tightening via the balance sheet, and if inflation is already sub-2%, there was little hope for near-term hikes, and this was a driving factor to the major sell-off that showed-up in the Greenback in the second and third quarter of the year. But at Chair Yellen’s speech two weeks ago, she indicated that the bank may not be looking to wait for inflation to tick above 2%, even while beginning to whittle the balance sheet down, and this gave USD strength another shot-in-the-arm.

The Dollar continued higher in the early portion of last week, until running into this key zone of resistance that runs from 94.08-94.30 on DXY, which continues to hold as we kick off this week.

U.S. Dollar via ‘DXY’ Daily: Current Resistance in Key Zone from 94.08-94.30

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

This week’s economic docket offers a couple of potential drivers that could impact this trend. Wednesday brings FOMC meeting minutes from the September rate decision, and Friday brings CPI and Advance Retail Sales. All of which are high-impact prints, and each of which can bring fresh buyers or sellers into USD.

As we wrote in the Q4 forecast, one of the most positive aspects of the U.S. Dollar at the moment is just how negative this year has been. After falling by as much as -12.33% from the second trading day of the year into the September lows, there were few on the sidelines that wanted to sell that hadn’t yet already. This can make a market extremely vulnerable to ‘short squeeze’ scenarios, similar to what was seen in the Dollar in August, before the Jackson Hole Economic Symposium drove another spate of weakness into USD.

At this stage, with price action threatening to break-above a very key zone of resistance, there is a very realistic possibility of a continued move-higher here, particularly as we see a short-heavy market get further squeezed by a persistently-hawkish Federal Reserve. On the four-hour chart below, we’re looking at the bullish structure that’s shown-up since early-September as a series of higher-highs and higher-lows. We’re also looking at that long-term zone of resistance cast atop price action, and if this resistance is going to hold, we should see those prior swing-lows taken out as the ‘bigger picture’ down-trend shows back-up. But – if we don’t get downside tests/breaks of these shorter-term higher-low support points, the prospect of bullish price action remains in USD.

U.S. Dollar via ‘DXY’ Four-Hour: Breaks of Higher-Low Support to Signal Return of Down-Trend

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

Bulls on Break in EUR/USD; But When Might they Return?

Going along with that retracement in the U.S. Dollar’s 2017 down-trend has been a pullback in the previously uber-bullish trend in EUR/USD. As the Dollar was getting crushed for most of the year by markets expecting the Fed to be even-more dovish while rolling out balance sheet reduction, the Euro has been driven-higher by markets expecting the ECB to inevitably begin tapering their stimulus outlays.

At this point – we have no indication that the ECB is actually going to do this. We simply have the deduction that the current program is set to expire in December, the ECB has two meetings left in this year (October 26th, and then December), and growth and inflation have begun to show with a bit more consistently in the bloc.

The ECB, for its part, has remained extremely evasive on the issue. When posed directly with the question of whether the ECB had discussed stimulus exit, Mario Draghi has continually deferred by saying that the bank hadn’t even talked about it. When this happened in April and June, those deferrals brought a couple of weeks of pause to the currency’s up-trend; but in July there was a far different response, and then at Mr. Draghi’s speech at Jackson Hole – where he didn’t even touch the topic of monetary policy but instead spoke about the benefits of open borders –the Euro hurriedly ran above the 1.2000-figure as rate hike bets hit fever pitch.

But the psychological level of 1.2000 was unkind to Euro bulls, and after repeated attempts to sustain a topside break, EUR/USD sank below below and resisted the under-side of this level a few weeks ago, before pulling back to find a key zone of long-term support.

EUR/USD Four-Hour: Struggle to Sustain Above 1.2000, Pullback to Key Support Zone

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

Since first re-arriving at that zone of support a week-and-a-half ago, Euro bulls have continually attempted to cauterize the lows but, at this point, have been unable to turn the tide of selling pressure as lower-highs continue to show. Prices finding support at the bottom of the zone last week, around 1.1685, before resisting at and then climbing above the top-side of the zone at 1.1736, are an encouraging first step for those looking to play a return of bullish price action in the pair. But an actual higher-high on the hourly chart would be a lot more convincing. On the chart below, we’re looking at recent swing-highs in EUR/USD.

EUR/USD Hourly: Return of Bullish Price Action on Hourly to Signal Return of Bulls Long-Term

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

USD/JPY Builds into Range Atop Resistance

If we are sitting in-front of a grander move of USD-strength, the pair that will likely remain as one of the more attractive vehicles for such a theme would be USD/JPY, and we talked about this at length in last Thursday’s webinar, just ahead of Non-Farm Payrolls. While many Central Banks wrestle with the prospect of tighter policy options, that’s not really an issue of concern for the Bank of Japan, at least not currently. Inflation remains extremely weak, and with the BoJ headstrong towards their 2% target, which they likely won’t hit for at least a few years even under the most optimistic expectations, it doesn’t appear as though we’re going to hear the BoJ taking a step back anytime soon.

The one hindrance is just how much stimulus they’ve done so far, as the BoJ is acquiring significant market share of both Japanese Government Bonds and Japanese Exchange Traded Funds. But with little downside risk shown thus far, the BoJ doesn’t appear to be very moved by this risk; and after last month’s BoJ rate decision had a dissenting vote for even more stimulus, it doesn’t look as though we’re going to have to contend with higher rate expectations out of Japan anytime soon.

For its part, USD/JPY has been range-bound for the majority of 2017. Starting in April, USD/JPY began oscillating between support around 108.00 and resistance around 114.00. In the middle of this range is a key zone of longer-term support resistance that runs from 111.61-112.43.

USD/JPY Daily: Resist, Break, and then Support at Key Zone from 111.61-112.43

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

Over the past week, a range has developed on top of that zone, with the prior point of resistance at 112.43 helping to set current support after a downside test around last week’s NFP report. For those looking at adding bullish exposure into the U.S. Dollar, this could be an interesting vehicle as the BoJ will likely remain as one of the more dovish Central Banks. The current setup in USD/JPY could be interesting with stops investigated below the prior swing low around 111.45, and targets cast towards range resistance of the shorter-term range at 113.25 and then the longer-term range around 114.00-114.50.

USD/JPY Hourly: Scaling-Higher Through Resistance, Short-Term Range Atop Key Zone

U.S. Dollar Turn or Burn: EUR/USD, USD/JPY Primed

Chart prepared by James Stanley

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

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