Why the Forex Market can change
As you know, once a month we examine 29 currencies for evidence of popular delusions and crowd madness. The idea is to find anomalies and bullish or bearish divergences that will break the trend, not prolong it. It’s a painful exercise, but also a very rewarding one.
In order to find the most overbought and oversold currencies, I conduct five econometric studies: over-extension analysis, analysis of secular performance, examination of oil correlation, analysis of economic divergences and study of effective exchange rates. In addition, I examine the positioning of operators to understand the psychological state of the market.
COVID-19 and Forex
See below the outlook for the world’s major economies (China, the euro zone and the United States) for two scenarios: one with and one without a second wave of the virus.
Although lockout has resumed (particularly in Europe), the baseline scenario assumes that the virus remains reasonably under control. However, there will still be enough negatives in place to cause a double dip in the fourth quarter of 2020 and a possible spread in the first quarter of 2021. As a result, central banks’ monetary policy is likely to remain « broadly accommodative » (flexible credit policy).
Although there is no consensus among economists on the economic outlook for 2021, there is certainly agreement that growth in 2021 would be weak at best. Moreover, central banks’ attempts to normalize monetary policy will be jeopardized by continued low inflation.
Forex traders need to be vigilant about competitive devaluations, as countries around the world are taking steps (implicit or explicit) to depreciate the value of their currencies in order to boost exports and revive the economy. In this regard, it becomes particularly important to monitor the relative value of currencies. This is exactly what my econometric studies try to achieve. Below are the latest results.
Before revealing the results, let me say a few words about the current global market environment. This is important because global macroeconomic conditions cannot be measured numerically and cannot be directly factored into econometric models. They have to be studied in qualitative terms. In my view, the two most important issues impacting the global foreign exchange market at the moment are the US presidential elections (+ the impact on the dollar and the implications for US-China trade relations) and the spread of the coronavirus (+ the possible economic damage it may cause).
The American elections
The US elections are crucial for the EUR/USD’s next moves.
If Biden wins and the Democrats also manage to take control of the Senate and House, they could then quickly pass a generous stimulus bill. In this scenario, there is a significant drop for the dollar and a rise for the EUR/USD.
If Mr. Trump wins, a new term in office could allow him to push for a bigger stimulus package. In that case, the EUR/USD would rise, but not massively.
The worst-case scenario would be if the election results were contested. Prolonged legal battles and potential street violence could be detrimental to the markets. The dollar, a safe-haven currency, could soar, causing the EUR/USD to fall.