Forex Trading and Fiscal Cliffs

The currency markets are a bit volatile now, led by the US dollar, which won't settle down until the election is sorted out. But Europe and Asia have their own issues as well, so the dollar long-term is fine, says senior currency analyst Alfonso Esparza of OANDA.

Gregg Early: I'm here with Alfonso Esparza, who is the senior currency analyst at OANDA. Alfonso, I wanted to start by asking you about what we're seeing in the currency shifts.

The dollar seems to be weakening, I don't know if that's a factor of QE3 kicking in. The euro is staring to strengthen here. Maybe the dollar is weakening because of the euro. I don't know what the relationships are. The fiscal cliff gets thrown in, and the election. So could you clarify some of these things for us?

Alfonso Esparza: I think you are right that QE3 and the fiscal cliff have had an effect on the US dollar, but I think what we're seeing right now is that the major factor is the elections.

When you have an election, you basically have two people running for the same job, so there's uncertainty of who's going to get the job at the end of the day, which in this case is two weeks from now. So that has affected the US dollar against all the major currencies and emerging markets.

That's not to say that Europe is not without its troubles, or there are really questions about recovery, but the US story is one about soft economic data on one hand and uncertainty on the other. But once that uncertainty ends and we have a president-elect, then we'll start moving forward with the US dollar and it will recover.

Gregg Early: So basically, what we're seeing is the market hates uncertainty, so investors just move out of where things are uncertain in the short term and wait to see what happens. Then the money flows come back in.

Alfonso Esparza: Yes, so we've seen that. That explains a lot of the US side. On the Europe side, we've seen economic uncertainty and softness in terms of some decisions, but the main difference is that they don't have as big shifts as the US, and their institutions have stepped up in terms of statements. They're constantly reassuring.

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The European Central Bank has done this almost every week. They come out and say they like everything. They'll support the struggling economy. They'll support Spain and Greece. So they've been more proactive in that sense, so the euro is getting a boost from that political rhetoric.

Gregg Early: Well, also they don't have the looming fiscal cliff after the election. I would assume that when you have an election which is becoming more and more polarized as we get to Election Day but also after the election, this fiscal cliff, I can't imagine it does anything good for the dollar.

Alfonso Esparza: Sure. That's always one of the biggest challenges that any president has to deal with. But I would say that in Europe, the problems are even bigger, because it's not only one fiscal cliff. It's multiple cliffs; we're talking about five or six happening at the same time. It's just that they don't have that on top of an election.

Gregg Early: I see. I guess the other thing would be they would dilute this issue by having six elections as well. So, they have six fiscal cliffs, but they'd have six elections, which kind of dampens the blow a little bit.

Alfonso Esparza: Yes, and because of the political structure, it changes. Sometimes it's a president, or a prime minister. It's a bit more convoluted, and they're using that to their advantage right now.

Gregg Early: So what's the play here with the dollar then? Is it to move out of dollars? I would guess too this would affect countries that are somewhat pegged to the dollar, say in South America, where you have Ecuador that uses the dollar and other countries down there that are pretty tightly connected.

Alfonso Esparza: Well, traditionally the dollar has always been a safe haven, so whenever there's uncertainty in the world, the money flows into the US. Even though the economic factors have not been so strong, the dollar has not fallen as much as it could have.

But what we're seeing right now is, what happens if the uncertainty is in the US? And there's uncertainty everywhere. We have uncertainty in Europe. There's a slowdown in China, which directly affects Japan. So, what happens then?

I think what we're seeing right now is everyone is diversifying their safe haven. They're going a bit into euros, a bit into dollars, and a bit into yen. They're trying to find the strength wherever they can find it.

Gregg Early: So even though the dollar has weakened, it's not like it's on this path to hyperinflation as some people say, the dollar is on its way to zero and we're going to walk around with wheelbarrows full of money to buy a cup of coffee.

We're not looking at something dire like the beginning of the end. This is more or less a macro transition to multiple safe havens, as opposed to using the dollar as the safe haven of the world.

Alfonso Esparza: Yes, basically, that's correct. And as I said, on top of an election that makes it even more, it's a factor of movement that would have been seen if there was just a Europe and China slowdown and the US with regular economic conditions. We would probably see more money flowing into the US, but if you add that level of electoral uncertainty, then you're starting to see that split that we're seeing right now.

Gregg Early: So, strategically, if you were a forex trader, an individual for example, that's looking to make some short-term trades with the knowledge that most of these currencies are stabilizing here, it's more or less news-driven events, probably the dollar in the short-term maybe being the weakest of the majors.

Alfonso Esparza: Yes. So in terms of the discipline or what needs to happen in order to sort of follow the market in this current condition, right now, your best bet as an investor is to follow the calendar. See what's out there, learn what's happening.

For example, this weekend there was the European Summit, things like that. There always are a lot of statements that come out. A lot of economic decisions are being made on the weekends right now. So, just follow that and help an investor decide his strategy for the short- and mid-term.

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