By Patrick Foot, financial markets writer at IG. Find out more about the currencies discussed in this piece at: http://www.ig.com/uk/forex-trading

So far, much attention has been paid to the staggering performance of US indices in 2014. The debate over whether a correction is long overdue appears to be swinging in favour of the bears; though that correction is still to materialise.

The USD has not yet been able to recreate that impressive performance against two of its major pairs, the GBP and JPY. Little wonder, as Janet Yellen and the Federal Reserve appear resolute in their intention to keep interest rates at rock bottom for the foreseeable future. In times of impressive, if perhaps unsettling, growth for equities an eerily quiet currency in a cautiously steady economy offers little to attract investment.

Instead, investors last week turned to safe assets as a defensive action against possible volatility, in a move that saw gold increase in worth and the dollar drop further against the yen. That erased the good run seen up to Independence Day, and left the dollar at around 3% down on the beginning of the year. Cable tells a similar story, with the pound growing around 3% on the dollar for 2014 so far.

A strong pound combined with the jitters caused by volatility in European banks are clearly hurting the US currency; but there are plenty of reasons to be optimistic about the fate of the USD.

This unusual period of calm in forex has to end at some point, as each day passes the likelihood increases that something will kick the forex markets into life. There’s a fair chance that the catalyst for forex will come from an unexpected quarter, though it may also be driven by movement of major indices.

The uncertain bull market in the US and Germany needs to stabilise soon, either with a correction or with a more gentle movement. When that happens, appetite for risk and the US dollar should increase, at the expense of the JPY and other stable assets. A correction would probably cause a fair amount of volatility for equities investors, but would also increase confidence in the markets. Should the Dow Jones, S&P 500 or DAX begin trading at more normalised levels, some life should return to the dollar.

One of the major stories coming out of the recession – the inexorable rise of emerging economies – has dissipated somewhat this year. PricewaterhouseCoopers have reduced their prediction for how quickly some of the BRIC nations may challenge major economies, stating that only India will join China in the top five over the next 16 years.

That lack of disruption should prove positive for the US, as major European competitors and Japan drop off whilst they remain at the top of the pile. Forex doesn’t tend to be a market with a long term outlook, but after the negative news surrounding the US economy for the first half of the year, it does appear to have turned a corner.

Nothing illustrates that fact better than the recent economic announcements, with five consecutive non-farm payrolls reports coming in above 200,000. Of those, the surpassed targets with 288,000 jobs added: well above the 215,000 expected by the market. Unemployment also dropped to 6.1%, the lowest since the Lehman Brothers collapse six years ago.

If news continues to be positive, interest in the US economy should rise and the dollar along with it. More importantly, however, it will add confidence to those who believe that the time has come for Janet Yellen to change tack and raise interest rates. That confidence may well be misplaced – the Federal Reserve has remained adamant that interest rates will remain low for some time yet – but the markets don’t trade on facts alone and positive sentiment could push the USD higher against the GBP and JPY.

The willingness of the markets to embrace such moves can be seen in the immediate aftermath of the non-farms release, when the GBP lost 136 pips against USD and USD/JPY and increased by 26 pips in an hour. Neither of those movements held, however, and dollar quickly fell back against both currencies indicating that the current positive economic news does not appear to be enough to sway investors.

It may not have happened yet, there are plenty of factors to watch in the rest of the year that may well have a big impact on the dollar. It would not be wise for investors to start ignoring the currency yet.

About the Author

Patrick Foot is a financial markets writer at IG.com

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