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US Dollar Braced for Worst as Traders Prepare for Greece, Fed

US Dollar Braced for Worst as Traders Prepare for Greece, Fed

2012-06-15 22:45:00
David Rodiguez,
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US_Dollar_Braced_for_Worst_as_Traders_Prepare_for_Greece_body_Picture_5.png, US Dollar Braced for Worst as Traders Prepare for Greece, Fed

US Dollar Braced for Worst as Traders Prepare for Greece, Fed

Fundamental Forecast for US Dollar: Neutral

The weekend’s event risk poses a true existential threat to the stability of the Euro Zone and Euro itself, and the US Dollar (ticker: USDOLLAR) stands to strengthen as the world’s benchmark safe-haven currency. Of course Euro declines are far from definite, and we urge that traders use caution on what threatens to force substantial volatility and challenging trading conditions in the days and weeks ahead.

All eyes remain on Greek elections as an outright majority victory by the far-left Syriza party could literally force Greece out of the Euro Zone, but volatility is likewise seen ahead of a potentially pivotal US Federal Reserve interest rate decision. The Dow Jones FXCM Dollar Index (ticker: USDOLLAR) saw its single-largest weekly decline since early January ahead of the critical event risk. Predicting the outcomes for Greece or the Fed with any real certainty is nearly impossible, and traders should be ready for a number of surprises and sharp moves whatever the outcome.

The key factor that will ultimately drive volatility is simple: traders remain braced for the worst as speculative futures traders are their most net-short Euros against the US Dollar in history. In that sense there may actually be downside risk for the US Dollar (upside for EURUSD) on anything but the most bearish of outcomes. If traders are holding US Dollars as insurance against or speculative positions on a Greek exit from the Euro Zone, a result that keeps the troubled Hellenic Republic in the EMU may force many to close their trades. A rush to close leveraged Euro/US Dollar short positions could force a dramatic rally.

FX Options markets show traders predict the Euro/US Dollar could average impressive 200-pip ranges every day in the coming week—what would be the highest average since the Euro set a noteworthy top at $1.38 in November, 2011. It was at that point that the Euro peaked at $1.3817 and fell by 370 pips in the subsequent five days.

Expectations for Wednesday’s US Federal Open Market Committee rate decision will likewise depend on the weekend’s turn of events. Fed interest rates are essentially at zero percent and literally cannot go any lower without turning negative. Thus focus remains on whether the US central bank opts to boost monetary policy stimulus via unconventional asset purchases (i.e. Quantitative Easing) or shifting the composition/maturities of assets currently held on their balance sheet (e.g. Operation Twist).

We view non-trivial risks that the Fed may in fact announce further stimulus via more QE or even another version of “Operation Twist” as recent inflation and employment data leave scope for easing. The probability of any such action grows significantly if the weekend’s Greek elections force major dislocations in global markets. In fact, the Fed’s transatlantic counterpart in the Bank of England has already announced plans to bolster the UK economy in the face of significant market strains.

Could the US Dollar fall if the Fed decides to ease policy further? Perhaps. Yet it’s worth noting that any new emergency actions could just as well stoke fears that current financial market issues are really worse than most people appreciate.

It promises to be an exceptionally volatile stretch for the safe-haven US Dollar, and traders should use caution and limit leverage amidst the risk for especially large currency swings. - DR

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