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Dollar Slides as Fed Forecast Balances, EUR/USD Mounts Liquidity Surge

Dollar Slides as Fed Forecast Balances, EUR/USD Mounts Liquidity Surge

John Kicklighter, Chief Strategist

Talking Points:

  • A retreat for the Dollar, Treasury yields and implied Fed Funds rate Thursday reflected rate speculation rebalance
  • The dramatic two-minute, 130-pip EUR/USD rally in dead hours between US and Tokyo was the result of liquidity
  • Don't let speculation out-reach reasonable trading forecasts in the fading liquidity of 2016's last trading day

See how retail traders are positioning in the majors using the DailyFX SSI readings on the sentiment page.

There have been some remarkable moves developing in the more liquidity areas of the FX market. However, rather than conflict with the thinning liquidity conditions, this is strong evidence of that quickly diminishing market participation. The more steadfast move this past session came from the Dollar itself. A slide from the ICE DXY Dollar Index pushed the benchmark to the bottom of its own two-week range and nudged benchmark pairs like the EUR/USD to comparable technical boundaries. A look to Treasuries, Fed Fund futures and other yield sensitive assets reveals a common thread of rate speculation. With year-end adjustments in full swing, one of the more prominent speculative runs over the past few months was the Greenback's surge on the backdrop of building rate expectations. Rebalancing (some would say risk reduction or profit taking) is what we would expect from the speculative rank.

The extreme volatility to start this final trading day of the year, on the other hand, was distinctly disorderly. The EUR/USD drove through 1.0500 on a dramatic run that spanned more than 130 pips in just a couple minutes. While technicals contributed to this drive and there was a reason (fundamentals) for the big player behind the initiation, it was really the market conditions that made this drive possible. The extreme illiquidity of the pre-Tokyo session combined with general decline in implied volatility these past weeks and the seasonal collapse in depth expected at year end to make for a very shallow market that would not easily absorb a large order. Looking at EUR/USD futures, the short-term (5, 15, 60 minute) volume proved extreme - with no truly comparable move for the time frame since the US Presidential election. Given the girth of this particular pair, it comes as little surprise that it spilled over to the Dollar and Pound crosses. The issue though for industrious traders is that this would be very difficult to leverage for further trade opportunity.

Through the final 24 hours trading session, liquidity will only further thin out. That can lead to further drama in volatility and surprise flare ups. Yet, there is no clear probability or sound timing to be made of these events to make them viable opportunity. Even for those with a high risk threshold, these are not conditions that are conducive for sussing out trades. It is better to keep tabs on underlying trends that are clearer or more exaggerated when there isn't market depth to fuel it. Risk trends is one such key theme. A pullback for the S&P 500, Yen crosses and some other sentiment-motivated assets looks like a means to ease back the throttle from the yield chase. It will be important to see if the speculative rank picks the baton back up after the pool fills back out after the New Year. We discuss what to watch and what avoid in today's Trading Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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