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A momentous week for Forex as the market was shocked by the Fed’s move to raise rates in the Discount window. This is the rate with which funds can be traded with the Fed, and it was the first time I can remember that this rate was shifted and the Fed Funds rate did not move at the same time. This caused the Dollar to surge and that is not surprising. History tells us that once a change in trend in interest rates begins it is a long time before it shifts back the other way. America now joins Australia in a tightening bias and for the former this has some important underlying dynamics.

For some time now the Dollar has been the primary beneficiary of what is called the Carry trade. This involves borrowing money cheaply here and using it to buy assets elsewhere. This is fine as long as the currency borrowed does not significantly appreciate. We now have the situation where the outlook for cheap borrowing can shift and provides two arguments for further Dollar strength. Firstly, if the carry continues it is more likely that traders will look to hedge the risk of Dollar appreciation by buying Dollars on the forward market, thus creating a powerful underlying bid. Secondly, any further strength opens up the possibility that existing carries can be unwound, or further hedging is needed in order to continue to hold the position. It is also worth noting that the Dollar has been rallying in spite of other news that showed that China was a net seller of U.S Treasuries in November. Whilst this is some way back in history it will become very instructive to the size of the Dollar bid if this trend continued in December and January and is something I will watch closely.

Technically the Dollar slumped alarmingly late on Friday and highlights another market dynamic I look at closely. Moves right at the end of the week are always treated with suspicion due to thin conditions and day traders being forced to exit. This means that Monday’s price action will be very instructive in whether the move was true or false. Compounding the importance is the fact that the EUR/USD settled directly at the point of most time in its downtrend that began is January. When price ends the week at the ultimate point of fair value, it dictates that the market is at a pivotal time and must make a decision on its next trend. It means watching 1.3840 on the upside and 1.3559 on the downside.

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