One of the most confounding mysteries currently confronting the forex market is the dramatic drop of the US dollar. Few recent trends have continued for as long, or proved as lucrative, as the enduring fall of the currency since a new low was first reported on in summer 2014.
Forex brokers and traders watched, cautiously, as the EURUSD pairing broke the 2010 low, threatening to hit levels not seen since 2005 at 1.1640. Simultaneously, USDJPY’s 2007 high began to draw attention at the next upside target, at 124.41.
Despite this move higher, traders have remained unwilling to trust in the recovery of the currency, which has not been supported by a firm multi-percentage correlation. As a result, more and more of them are turning to foreign currencies in search of clues as to the future of the US dollar.
The Significance of Exotic Currencies
Although there is a tendency within the forex market to overlook them, exotic currency trends can provide a useful tool in the determination of the true state of the US dollar, helping to uncover whether it’s favoured across the board or only against low-yielding FX.
At the current time, a depressed interest rate environment largely defines the world economy. With interest rates having been lowered around the globe in line with the aims of quantitative easing programs, an assessment of the performance of individual currencies can be distorted. This is where exotic currencies come in useful, as the economies whose interest rates have remained high provide a unique look into the performance of the low-yielding US dollar.
For those with an understanding of the bond market, parallels can be drawn between the role of these exotic currencies and the section of the junk bond faction. The junk bond faction is made up of companies with lower credit ratings than the blue chips that most people are familiar with. The performance information they provide is unique, and can be used to provide a more coherent picture of the market in terms of rebounds in risk and fluctuations in risk sentiment before they become obvious through comparisons with other sections. Similarly, exotic currencies provide a unique insight into the position of the US dollar, and could thus provide an early opportunity to cash in on this.
The US dollar’s recent gain is largely attributable to an announcement made by the Federal Reserve, which claimed that the country was ending its multi-year quantitative easing program. With many other central banks not yet embarked upon or in the midst of their own programs, this saw the dollar gain against low-yielding currencies like the EUR, JPY, CFH and GBP.
This trend was all that certain factions of the market took note of. However, by widening the lens, we see that higher yielding currencies, such as the ZAR, did not respond in the same way.
A second statement by the Federal Reserve, a commitment to ‘patiently’ raise rates over the course of 2015, has also been instrumental in fuelling USD fever. Yet if we look to the story told by exotic currency rates, the tale is very different A Bearish Engulfing Pattern is evident for the USDMXN pair, suggesting that something could be amiss. Indeed, a break below the 17th December figure of 14.37 could catalyse a drop against other higher-yielding currencies such as the AUD, NZD and ZAR, amongst others.
So what does this mean for the forex market and the position of the USD going forwards? With high-yielding currencies showing strength against the former currency, a charge against it could well be in the offing. Indeed, should certain levels fail to provide continued support, a real correction may be on the horizon.