Uncertainty Reigns in Currency ETFs as QE2 Concludes Dollar Dilution 

Written by Tom Cleveland, contributor for forextraders.com      
 
Uncertainty has been the name of the game in our trading markets for more than a year.  The rollercoaster began in May of last year when the Greek deficit tragedy bounded onto the global stage in reckless abandon, only to highlight that deficit issues were more widespread across its weaker member states’ respective balance sheets.  Yes, a rally in stocks and commodities did commence, but the Fed’s quantitative easing program, or “QE2”, only helped to dilute the Dollar and increase cash balances for banks.  Currency markets witnessed more volatility than expected, but the direction of the global economy, after this wild ride, is once again in doubt.

Volatility has eased, but most experts believe the present slowdown is temporary, brought about by increasing oil and commodity prices that have been reined in a bit lately.  Fundamentally, eyes are still focused on Europe and its quest to dampen concerns over potential bond defaults by the “PIIGS”.  Greece has adopted austerity measures as proposed, but riots in the streets continue to be a common occurrence.  Beyond Europe, the most influential news has been the Fed’s announcement that QE2 was over and that there were no plans for a QE3 anytime soon.

How have currency ETFs reacted to these pronouncements?  The message from the chart below is indicative of the uncertainty that still rules the market’s consciousness.

The U.S. Dollar Index is comprised of six currencies, but the Euro, Yen, Pound, and Loonie make up more than 93% of the weighting.  Comparisons of Currency ETFs for these four currencies are presented above, relative to a “bullish” Dollar Index fund.  For the past few months as QE2 wound down, the Greenback hit a new 16-month low in May, but only improved slightly once the Fed announced its true intentions.  Each of the above currencies also improved slightly versus the Dollar over the entire period, although the market favored a discontinuance of the domestic stimulus program.

If the market truly discounted QE2’s end, then where will currency ETFs move in the future?  The chart above does not give many hints as to the answer of this question.  A sideways, ranging motion has been prevalent in each fund, a reflection of market uncertainty.

The Yen has definitely appreciated, leading many to question whether the Dollar will be buffeted by its “safe haven” status if global unrest persists in the Middle East or elsewhere.  Many believe that the Yen and the Swiss France may assume this role if events dramatically change on the global stage.  Debt and deficit issues in the United States have yet to be fully addressed, as the Congress seems deadlocked over plan principles for approving a raise in the current debt ceiling.

Back in April, many of the world’s best currency forecasters, known for their accuracy in this arena, opined on the fate of the Dollar after QE2 ended.  There was a general consensus that weakness would prevail, perhaps, not a new low in the index, but a minor improvement to a new support level for the balance of the calendar year.

Is there money to be made in currencies under this scenario?  Uncertainty breeds its own version of volatility, and where there is volatility, there is always opportunity for gain (or loss) for those willing to take the risk.  The Euro will continue to fluctuate, despite the rhetoric from finance ministers.  Greece must rollover a major portion of its debt in August, so beware.

As a new round of bailout discussions ensues, guidance will come from economic data releases.  Stay tuned to the news, and react accordingly!