Trade the Debt Deal with Currencies

08/02/2011 6:00 am EST

Focus: FOREX

The US debt deal is the major news event driving the financial markets this week, and for currency traders, pairs including NZD/USD, USD/CHF, and EUR/USD are good choices for playing it.

With the August 2 debt ceiling deadline now upon us, there is still uncertainty regarding the eventual outcome. If you think the resolution is US dollar (USD) bearish, then look to trade the New Zealand dollar (NZD)/USD or the USD/Swiss franc (CHF) currency pairs. If you think the resolution is USD bullish, then look to trade the euro (EUR)/USD pair.

US Congressional leaders are reviewing the latest proposal to increase the US debt ceiling and feel they have enough votes for a deal. Voting began late Monday in the Senate and may carry over into Tuesday for the House of Representatives if there are any sticking points. To help guide us on how to trade the US dollar through the crisis resolution, we’ll look at relative strength and weakness of the greenback versus the other major currencies.

The August 2 debt-ceiling deadline has been understood by markets and politicians for a few months now. We will look at July’s price movement to help us see what the markets may be indicating regarding relative strength and weakness of the US dollar.

Here are the monthly pip movements of the USD relative to the seven other major currencies. A negative number represents the USD losing ground. A positive number means the USD strengthened in that pair.

By determining the net pip movement in July, which was a recent month where the August 2 deadline is known, we see that the CHF and NZD have shown relative strength through the negotiations thus far. On the other hand, the EUR has been relatively weak, having lost ground against the USD.

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The green highlights mean that the USD has lost the most ground in July 2011 relative to the CHF and NZD. Therefore, if you are anticipating additional US dollar weakness ahead, then look to trade the USD/CHF or the NZD/USD.

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The New Zealand dollar gained 501 pips against the greenback during July 2011. So long as prices remain above .8615, the pair technically has a bullish bias. Look for the green line (.8765) to offer support and consider a buy trade in that zone.

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If you feel the USD may gain strength, look to sell the EUR/USD pair, as the EUR was the only currency against which the dollar strengthened in July 2011.

A breakout strategy can be used where you would let the market prove to you it is wanting to trade at lower levels. Place an entry order to sell below the 1.4230 zone. If prices push to this level, it would be creating a series of lower highs and lower lows.

By Jeremy Wagner, lead trading instructor, DailyFX.com

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