Are divergence trades dead and will this permanently depress the value of the USD? Asynchronous EM and Developed country business cycles, and sharp output/unemployment gap differences within DM, still favor USD positive policy divergence medium-term. Even very gradual Fed tightening will take the USD into ‘G10 high yield’ status into 2017.
If this is ‘peace’, how long will it last? Risk appetite is likely to remain unstable/volatile in 2016. The FX market is extremely tactical, and is inclined to play risk appetite from one Fed meeting to the next. Example: If the April FOMC is ‘dead’, and the June FOMC is “LIVE”, then soon after the April FOMC meeting, the risk pendulum will swing more negative.
Is this a new USD upside constraint? In prior big USD cycles, it used to be that a strong USD’s impact on US trade accounts was the main emerging constraint to further USD strength. This cycle is much more complex than that. The growing understanding of the USD’s rapid appreciation in encouraging market instability has to be registered as one factor restraining (but not stopping) the USD going forward.
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