The forex market experienced a relief rally as G10 currencies gained against the US dollar (USD). This surge followed reports suggesting a possible delay in tariffs. Investors are now questioning how far this rally can go.
The rally started with optimism surrounding a potential shift in US trade policies. UBS strategists used a short-term valuation model to analyze this movement. Their findings suggest that the relief rally may not be long-lasting.
According to UBS, the Euro (EUR), Australian dollar (AUD), and New Zealand dollar (NZD) were the most misaligned currencies at the beginning of the week. Their fair values (FVs) were estimated at approximately 1.0450, 0.6400, and 0.5750, respectively. While the EUR might continue to strengthen, UBS remains cautious about the AUD and NZD due to persistent economic challenges in China.
Despite the short-term drop in USD, analysts do not foresee a prolonged weakness. UBS strategists believe that USD pullbacks present buying opportunities. They argue that, aside from the Canadian dollar (CAD), long USD positions are not excessive enough to trigger major corrections in EUR and Japanese yen (JPY).
Furthermore, the Bank of Japan (BoJ) meeting scheduled for January 24 could impact JPY movements. The market has already factored in a 22-basis-point hike. Therefore, even if the BoJ raises rates by 25 basis points, it may not significantly boost JPY. However, UBS's equity hedge rebalancing model suggests potential JPY buying at the month's end.
The EUR has shown strength over the past two years, despite weak economic fundamentals. This resilience is largely due to a strong Balance of Payments (BoP) surplus, supported by foreign bond inflows. However, UBS warns that this trend could reverse if political uncertainties in France persist.
So far, demand for French debt has weakened slightly, particularly among Japanese investors. Nevertheless, overall bond inflows have remained steady through November. Moving forward, investors should monitor this sector, as shifts in the Eurozone’s yield environment could influence EUR’s attractiveness to global markets.
The forex market relief rally has provided short-term gains for G10 currencies. However, UBS strategists caution that these gains might not last. While the EUR could continue strengthening, AUD and NZD face obstacles. Meanwhile, USD pullbacks may offer buying opportunities, and JPY traders should watch the upcoming BoJ meeting closely.
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