Risk Events Ahead of End of Year Flows

2017 ended, and we can say without a shadow of a doubt that the trend of the previous year was the EURUSD move from almost parity to above the 1.20 level. Like in a game of confirmation, the 1.20 mark came again during the end of year flows.

Such flows are often disregarded by Forex traders. However, this is a big mistake.

One must think of what the price action usually do during holidays. And the whole story starts before holidays…

End of Year Flows

December Trading is Always Tricky

The trading activity during December is always a tricky one. First, there’s barely trading activity at most of the trading desks around the world. There’s only supervision.

Junior traders supervise so there are no mistakes when/if the market moves.

Second, the more time passes in December, the more likely the trading algorithms will squeeze the week retail traders, so it is unlikely that the trends will change.

This is precisely what happened this previous December. The EURUSD squeezed higher and higher and the more the time passed, the closer to the 1.20 it came. Eventually, of course, it broke above.

However, here we are, almost two weeks after, and trading started in the new year. The EURUSD and all the other Euro pairs that followed the same path in the previous month gave back most of the games.

Suddenly, the end of year flows aren’t there anymore, and trading desks start to open one by one. After last week’s NFP numbers, we can say that virtually everyone is up and running.

Squaring Positions

To fully understand the Forex market, one should start from the basics. There are only two directions to take: long or short.

However, any of the direction taken must be squared by the time the trade is closed. This means that if you buy a currency pair and close it in profit or a loss, you’ll end up effectively selling the pair to mark the profit or the loss.

In doing that, you’ll add to the same trend that governed the markets during that period. The move, of course, is more violent, if traders are stopped, rather than when they close a trade to mark a profit.

Conclusion

The main risk during the end of year flows is that traders start the month on the wrong side of the market. Moreover, they live under the impression that the market won’t move, due to the low volatility that is typical for that period.

But, that’s only an impression. Of course, that sharp moves will push prices beyond extremes, and, if you want, there’s no better time to squeeze than holidays time.

Considering all the above, think twice before opening new positions when end of year flows are present.

Interest Rates and the NFP – What to Expect This Week?

The US dollar is in a free fall lately as sellers emerge on every spike higher. Despite the fact that the Fed is the only major central bank raising rates, nobody wants the dollar. Not even for a safe-haven status.

When investors look for shelter, they buy safe assets. Typically, in the Forex market, these are the JPY and the CHF currencies. But also the US dollar.

Not this time. It turned out this summer it was the Euro’s turn to squeeze. And, it did that in quite a fashion.

While the EURGBP cross pair moved almost vertical for the last four months, the EURUSD did the same. But what would be the reason for the EURUSD to move so aggressively against the dollar?

For sure, not the interest rate differential.

interest rates

Interest Rates in Eurozone and the United States

A quick comparison between the two leaves us with a huge interest rate differential. Favorable to the USD. Yet, it is sold across the board.

Being long on the EURUSD pair this summer paid the price. Even if the pair is one of the most expensive ones to keep over night. Because of the interest rate differential in favor of the dollar, the EURUSD longs have to pay a negative swap.

Effectively, at the end of each trading day, brokers deduct a small amount from EURUSD longs trading accounts. But it didn’t matter as the EURUSD pair overly compensated with such a strong bullish move.

However, the interest rate in the Eurozone is negative. Yet, investors favor the European currency instead of the USD.

On the other hand, in the United States, the Fed hiked the rates multiple times. Only this year, it did so twice.

While not much, the federal funds level sits at a solid 1.25%. And, the expectations are for the interest rate to rise still.

Friday’s NFP in Focus

With the recent decline over the summer, the USD is in the longest losing streak in the last fourteen years. That’s quite something considering the interest rate differential with other currencies.

The NFP this Friday has the potential to be a game changer. It may open the gates for the next rate hike in the Fed funds rate.

A solid print, however, is not something new. The strength in the US jobs market is evident for quite some time now. Unemployment rate keeps falling.

It must be accompanied by a rise in inflation. Then and only then, market participants will favor the dollar.

Because the Fed has a dual mandate, it looks at both inflation and jobs creation before hiking the rates. But those shorting the dollar must not forget the Fed is in the middle of a tightening cycle. It means the interest rate differential will rise. Eventually, traders will give up in search of the ever higher yields.

Conclusion

The market moves based on the fundamental and technical analysis. And, on supply and demand imbalances. But the Forex market is so liquid, that only when big players, or when macro economic dynamics change, the market will change.

Until then, it may still remain irrational. When this happens, usually retail traders get stopped. Almost all of them.