The Two Things Giving Currency Traders Sleepless Nights

As seen in the latest issue of Master Investor Magazine

Two things are dominating my fundamental bias in the currency markets at present. The first: the upcoming UK vote as to the country’s membership of the EU. The second: the potential for an interest rate hike out of the US. Both factors have markets at a sort of stalemate as things stand. If the UK leaves Europe, the chances are we will see some considerable weakness in sterling, and markets already seem to have priced this into the majors. Cable is down, and the euro is up against its UK counterpart. If the Federal Reserve decides to hike interest rates, and the most recent FOMC meeting suggests such a hike could be just around the corner, we should see some US dollar strength, and in turn, a compounding of the aforementioned cable weakness. Of course, when it comes to fundamentals, we never really know which way things will play out. This makes it difficult to project any sort of long-term bias – especially in the currency markets.

What does this mean for me?

Those who have read this column before will be familiar with my strategy. For those that are not, fundamental factors play only a minor role in my entries and exits; technical charting patterns are by far the more important element of my operations. With this said, the fundamental side of things is far more interesting. To be a little more specific, I enter based on breakouts through key (and predefined) levels on the major candlestick charts (GBP/USD, EUR/USD, AUD/USD and USD/JPY). These breakouts can come in any direction, short or long, regardless of the underlying fundamentals. Where the fundamentals come into play is in my risk management. If I hold a bullish fundamental bias in the US dollar, for example, just as I do now, I will be willing to be a little more aggressive on an upside trade (as signaled by an upside break) than if I was fundamentally bearish on the greenback. The same is true in reverse.

So, with that said, how am I using my fundamental bias in the above-mentioned two elements of the current global economic situation? First, let’s address the UK. The exact and far ranging consequences of a British exit from the European Union are not fully clear. One thing that is certain, however, is that sentiment towards the UK and its trade operations will likely sour (at least in the near to medium term) and this should put some pressure on sterling. We are already seeing markets price this in, with sterling down against the US dollar, the Japanese yen, the euro and the Australian dollar so far this year. Ahead of the vote, I expect this pressure to continue. If the UK remains a part of Europe come the referendum, we should see a jump in the value of sterling against its major counterparts – primarily as a correction against what would turn out to be an oversell ahead of the fact. Until this happens, however, my bias remains bearish, and I will be a little more aggressive to the downside and a little more conservative to the upside in the GBP/USD.

Looking at the US dollar, Janet Yellen suggested just last week that stress tests on the US economy point to the latter being able to withstand an interest rate hike, and this is driving bullish market sentiment in the dollar. Interest rates are the primary driver behind near-term currency movements, and a rate hike should see a flood of dollar buying on its announcement. Of course, I cannot say for certain whether the Federal Reserve will hike rates come the end of June, but sentiment certainly currently believes it might. This is enough for me to allow a little bit more upside on my bullish dollar entries, and conversely, a little less wiggle room on my downside stop losses.

Interestingly, and somewhat rarely, both of these biases have a distinct closing date. The UK referendum limits my potential scope on my bearish sterling stance (in that come referendum results day I will have to re-evaluate), and the end of June does the same for my US dollar bias. Until then, however, the above stands solid.

Here’s to a busy couple of months in the markets!