The last quarter of the years started with the U.S. equity markets making new historical highs. It seems that nothing can get stocks down, no matter if the news is geopolitical or comes from the economic area.
Perma-bears seem to be caught on the wrong side of the trade as many leading hedge funds bite the dust. The U.S. equity market rally continues with the Dow Jones printing values North of 22.6K.
The Forex Market and the U.S. Equity Markets
Typically, the currency market considers the moves in the U.S. stock market. Or, it is influenced by them.
That’s especially true when it comes to the USDJPY pair. However, the pair is nowhere near the vertical rise the Dow Jones made lately.
Not even the Fed’s hawkishness is not able to stop investors buying stocks. How come?
When the central bank starts a tightening cycle, the stock market hesitates. In the best-case scenario, the market will consolidate for as long as the tightening cycle continues.
However, not the case this time. There’s an explanation, though.
In their search for higher yields, investors find the U.S. stock market more appealing and safer than other financial markets around the world. Japan called for snap elections, the British and the Eurozone still argue on the Brexit bill, the Northern European countries and Switzerland drown in negative rates…where to put your money as an investor?
Hint: the stock market.
The U.S. Dollar as the World’s Reserve Currency
The same arguments are valid for the U.S. Dollar, though. For currency, the only thing that matters is the interest rate level.
And, the Fed was hawkish at the last FOMC meeting. Even the press conference’s tone was hawkish as well.
Not only that the Fed will raise rates one more time this 2021 (at least that’s the message left), but it’ll start unwinding the massive size of its balance sheet.
That’s unprecedented. Never, in the modern economy, such a thing happened. As such, all other central banks in the world will look and learn how the Fed will handle the situation.
Both actions (the interest rate hike and the balance sheet unwinding) are bullish for the dollar. If we add here the possible tax rate cuts the Trump administration envisions, we have the recipe of a perfect wind for the buck.
Yet, the Forex market is slow to acknowledge these changes. But, it only seems to be a matter of time until the move starts.
NFP Holds Key on the Short-Term
The January NFP is likely to be crucial. Many fear that if data disappoints until January, the Fed will derail the plans to hike the rates.
As such, they’ll look for this Wednesday’s data to be an indicator of the next rate hike. However, if you think of it, the data shouldn’t matter.
It so happens that the interest rate differential is so big (against the Euro, CHF, JPY, etc.) and rising, that traders have all the incentives to buy the dollar. Sooner or later, it’ll become evident.
Short-term, it could create volatility. However, long-term traders will use any dip in the dollar to establish new long positions.
Look at the end of the year to bring uncertainty in the Forex market. While the U.S. stock market is poised to rip higher still, the dollar will follow only if some of the scenarios presented here will become a reality.
Either Fed will hike the rates, or the tax rate cuts will come sooner rather than later…the dollar bulls only need a reason to push the greenback higher.