US Dollar Impasse Will be Broken by FOMC Meeting and GDP Update
Fundamental Forecast for Dollar:Neutral
A Fed staff forecast from June has changed the dynamics of speculation surrounding the FOMC’s rate timing
Be mindful of the back-to-back release of the FOMC rate decision and US 2Q GDP data this week
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How confident is the FOMC about its outlook for interest rates? Despite their rhetoric and clear predictions from the June forecasts, the market remains skeptical that that will be able to deliver a rate hike this year – much less two. This conflicting view will find some measure of resolution in the week ahead. Between second quarter GDP figures and the FOMC’s policy gathering, we will find both data and opinion to mark the pace of policy in the fading months of the year. There isn’t much time left for ambiguity and that means we may soon run out of room for consolidation.
With only four Federal Open Market Committee (FOMC) policy meetings left in the year, there is limited time to realize the group’s consensus forecast for 50 basis points of tightening. If the central bank is committed to seeing its normalization plans unfold within its time frame, they will have to start rate hikes in September. And, to temper excessive market volatility due to ‘surprise’ resulting from deeply held skepticism, the authority will need to use this week’s meeting to reinforce its commitment. This timing would conform to both the forecasted rate level at year end while keeping to their vow to move slowly (no consecutive hikes) and being as transparent as possible – without committing to policy.
However, just to make things interesting this past week; the media picked up on the Fed’s accidental, early release of a staff forecast produced for the June policy gathering. The report was supposed to be withheld from the public for five years, but was inadvertently released to the public – and left there on purpose since it was already in the open. What was particularly interesting in this assessment is that the ‘staff’ disagreed with the FOMC leadership on the pace of tightening. In 2015, the forecast was for a single 25 bp hike; while 2016 and 2017 year-end levels were also marked down.
This development will make the Wednesday FOMC decision that much more market moving. The official central bank forecast is the hawkish view with 50 bps, the group’s economists see 25 bps and the market is pricing 19.5 bps (denoting a 78 percent probability of a 25 bps hike). There is disparity here that inevitably must be closed as time passes that will see the Dollar either rise or retreat.
The FOMC decision is certainly the most direct update we will find for gauging monetary policy, but it may not provide the distinct resolution traders are looking for. At the very least there will be some sense of hesitation to adjust to updated views until Thursday’s 2Q GDP numbers are in the books. The US economy contracted in the opening quarter of the year and hawkish views have been built around expectations for a quick recovery - much like it did in 2014. – JK
Euro Weighed by Risk Repricing Post-Greece, Almost QE-driven Again
Fundamental Forecast for Euro: Neutral
- As EURUSD has steadied under $1.1000 after weeks of Greek-driven headlines…
- …the EUR-complex in general is starting to trade more to the tune of an ECB’s QE-driven market (but not fully yet).
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
If last week was an indication of things to come, then FX markets may be on the verge of reverting to a familiar trading environment: one driven by quantitative easing (QE) portfolio rebalancing channel effects. As the dust has settled around Greece, now that with each passing day the country inches closer to unlocking a €86 billion EFSF-sponsored aid program, the Euro has started to shake off the burden of being driven by Greek-related headlines.
The EUR-crosses were, and still are likely to be, driven by the broad notion that the Euro itself is a funding currency. Yet there may be a ripple or two to overcome before that environment is achieved again, and it’s the fallout from the market being tightly wound up around Greece for the past two months.
But for the fact that the US Dollar saw a huge leg up on the week after jobs data laid clear the possibility of a very strong July US Nonfarm Payrolls report, and therefore a higher probability of a rate hike in 2015 by the Federal Reserve, the EUR-crosses (saved EURUSD) moved in tandem higher. In the course of events as the EUR-crosses climbed, two other things happened this week: yields in Europe fell; and equity markets around the world fell.
What this price action across asset classes is indicative of is a repricing of the risk spectrum in a non-Grexit world. After both core and peripheral yields rose for weeks around Greek-related headlines, the removal of the Greek catalyst and higher probability contagion outcome reignited the demand for EUR-denominated debt.
The chain reaction lays clear now: now that core and peripheral European sovereign debt were overpricing the possibility of a negative event around Greece (hence the lower prices and higher yields), it made sense for traders/investors/fund managers to rebalance exposure in their portfolios; equities around the globe were sold in order to raise capital (explains weaker equity markets); said capital was converted into Euros (explains the rally in EUR-crosses); and said converted capital was invested in seemingly undervalued bond markets (explains the plummet in European yields).
In a truly bullish world driven by QE portfolio rebalancing channel effects, the Euro would depreciate amid lower yields and stronger equity markets (something that played out from December through early-March) (or vice-versa: the Euro appreciating amid higher yields and weaker equity markets, something that played out from March through June). However, an environment characterized by the Euro appreciating alongside lower yields and lower equity markets indicates that Greece’s hold on market forces has yet to fully resolve itself completely. –CV
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Japanese Yen Reverses Sharply, but Rally May not be Over Yet
Japanese Yen Reverses Sharply, but Rally May not be Over Yet
Fundamental Forecast for Yen: Neutral
The Japanese Yen finished the week nearly unchanged as an early-week surge gave way to a similarly dramatic late-week reversal. Its next move will almost certainly depend on the next developments in the ongoing Greek debt crisis and recent volatility in Chinese equity markets.
It was setting up to be an important week for the Yen as troubles in Europe and significant declines in China’s previously high-flying equity market led to a jump in demand for the safe-haven Japanese currency. And indeed the Yen remains in a position to outperform if market conditions deteriorate once more. Yet an important breakthrough in Greek debt negotiations and a noteworthy bounce in Chinese stocks led to a sharp improvement in broader sentiment; the Japanese Yen tumbled in kind. The next question is obvious: is this a lasting turning point or a false dawn for global equities?
Economic event risk will be limited next week and as such the focus will remain squarely on financial market conditions. With that in mind it will be critical to watch how Chinese and broader Asian markets start the week’s trading; recent correlation studies show that the Yen is among the most sensitive to moves in China’s Shanghai Index. The bounce in Chinese equities and the broader market rallies are certainly encouraging, but clear uncertainty remains.
Much of the renewed optimism comes on the heels of a positive breakthrough in Greek debt negotiations. Yet anyone who’s followed this saga over the past five years can tell you that things can and have changed in an instant. The coming week’s European Central Bank interest rate decision will be of special interest to Greece-watchers; any surprises from ECB President Mario Draghi could turn sentiment in an instant.
We’ll keep an eye on China, Greece, and broader financial market risk sentiment to gauge likely direction in the Yen. Volatility prices have picked up from recent lows, and we suspect we have not seen the last of the panic-driven JPY gains. – DR
British Pound Enters a Critical 10 Days Can it Continue Higher?
Fundamental Forecast for British Pound: Bullish
The British Pound failed to trade above key price levels against the US Dollar for the second-consecutive week as key FX pairs traded in tight ranges. A big week of both UK and US economic event risk nonetheless points to bigger GBP/USD moves in the days ahead.
Traders initially sent the British Pound higher as Bank of England Meeting Minutes improved outlook for the future of domestic interest rates. And yet the Sterling failed to hold onto key highs versus the Greenback—continued failure at important congestion levels near $1.5650 leaves short-term risks to the downside. A later-week disappointment in UK Retail Sales figures thwarted the Sterling once again as it attempted to test fresh highs. Traders now look to upcoming UK GDP growth numbers for Q2 to drive volatility across key pairs.
Analysts expect that the UK grew at a robust 0.7 percent quarter-on-quarter pace through Q2, and such a result would quite likely support the case for higher domestic interest rates through the turn of the year. Risks might be weighed to the downside on any disappointments, and the following week’s highly-anticipated Bank of England meeting looms large on the horizon.
The Sterling remains attractive relative to most major counterparts as analysts predict that only the Bank of England and the US Federal Reserve will raise interest rates in the coming 12 months. This fact certainly hasn’t changed since last week, and yet the GBP’s inability to press to fresh highs versus the Euro, Yen, and other lower-yielding counterparts reminds us that these themes can take months to play out.
Whether or not it presses to fresh highs in the week ahead will likely depend on results from the highly-anticipated UK GDP report and a US Federal Reserve interest rate decision. Barring outright disastrous UK data, however, we remain constructive on the Sterling’s chances versus all majors except the US Dollar. - DR
Gold Plummets for 5th Consecutive Week- Price at Support Ahead of Fed
Fundamental Forecast for Gold: Bearish
Gold prices plummeted for a fifth consecutive week with the precious metal down nearly 4.3% to trade at 1085 ahead of the New York close on Friday. The sharpest move for bullion came early in the session after prices broke below key support last week with continued strength in the dollar exacerbating the decline. Although the broader outlook for gold remains bleak, prices have responded to initial support and key event risk into the close of the month could offer a short reprieve to the battered metal.
The FOMC monetary policy meeting will be the main event next week with the central bank likely to reiterate its readiness to move on interest rates as US economic data continues to improve. On the back of last week’s Humphry Hawkins testimony it’s unlikely we will get any new material information from the release except a more updated view on where the committee stands on the outlook for monetary policy. Should the statement show a growing dissent among the members with regards to maintaining the Fed’s zero interest rate policy (ZIRP), look for the greenback to extend its advance to the detriment of gold. With market participants largely expecting liftoff this year, the risk remains to downside for the dollar if the central bank cites a more cautious/reserved outlook for growth & inflation. Such a scenario would likely limit losses for bullion which was battered down to a 5 ½ year low this week.
We noted last week that, “From a technical standpoint, gold broke below key support and the technical damage done leaves prices vulnerable while below 1150.” The subsequent sell-off saw a decline of more than $55 at its lows with this week’s range marking the largest since late November and the largest weekly decline since late October. The entirety of the week’s range was set at the open with prices encountering median-line support dating back to the 2014 high as weekly momentum approached 30-support.
Note that gold is vulnerable for a rebound at these levels heading into the start of next week. Near-term resistance stands at the 2014 low at 1130 with our bearish invalidation level steady at 1150. A break below ML support (~1070/73) targets objectives at the 1044/53 backed by a Fibonacci confluence lower down at 975/80. Keep in mind we’ll be heading into the close of the month with a break of the July opening range having already attained a late-month low & key US event risk on tap.
Swiss Franc Opportunities Seen Beyond Breakneck Volatility
Fundamental Forecast for Swiss Franc: Neutral
SNB Shocker Fuels Highest Swiss Franc Volatility vs. Euro Since 1975
Sharp Counter-Swing Seen Ahead if ECB Delays Launching QE Effort
Buying US Dollar vs. Franc Attractive After Post-SNB Turmoil Settles
The most adept of wordsmiths might be forgiven for struggling to find an adjective strong enough to describe last week’s Swiss Franc price action. A quantitative description is perhaps most apt: realized weekly EURCHF volatility jumped to the highest level since at least 1975, swelling to nearly 2.5 times its previous peak.
The surge was triggered after the Swiss National Bank unexpectedly scrapped its three-year-old Swiss Franc cap of 1.20 against the Euro, saying the “exceptional and temporary measure…is no longer justified.” Appropriately enough, the previous historical peak in weekly EURCHF activity occurred in September 2011 when the Franc cap appeared as suddenly as it vanished. Then too, the SNB acted without warning and sent markets scrambling.
The announcement caught the collective FX space by surprise. Even the world’s top international economic bodies were apparently left in the dark. IMF Managing Director Christine Lagarde quipped that she found it “a bit surprising” that SNB President Thomas Jordan did not inform her of the impending move. “Talking about it would be good,” she added.St. Louis Fed President Jim Bullard hinted the US central bank was not notified either.
The go-to explanation for the SNB’s actions centers around bets that the ECB will unveil a “sovereign QE” program following its policy meeting on January 22. Mario Draghi and company finally secured a green light for large-scale purchases of government debt after the ECJ gave clearance to the similar OMT scheme devised (but never used) to battle the debt crisis in 2012. The SNB presumably scrapped the Franc cap to avoid having to keep pace with the ECB’s efforts.
Another wave of Franc volatility may be ahead next week. While markets seem all the more convinced that an ECB QE announcement is in the cards after the SNB’s about-face maneuver, a delay in the program’s implementation (if not its formulation) is entirely plausible. Securing the acquiescence of anti-QE advocates like Germany to having such an effort in the arsenal is not the same as launching it. The ECB may yet opt to wait through the end of the first quarter as it has hinted previously before pulling the trigger, sending the Euro sharply higher.
Measuring the fallout from the SNB’s actions is likely to be protracted. The full breadth of the various ripple effects will probably emerge over weeks and months, not hours and days. The Franc now looks gravely overvalued against currencies whose central banks are set to tighten policy this year, with the US Dollar standing out as particularly notable. It seems prudent to let the dust settle before taking advantage of such opportunities however.
Bearish AUD/USD Outlook to Gather Pace on RBA/Fed Policy Divergence
Fundamental Forecast for the Australian Dollar: Bearish
AUD/USD slipped to a fresh 2015 low (0.7259) as Australia faces a greater risk of losing its AAA credit-rating, and the pair may encounter a further decline over the near to medium-term should the slowdown in China – the region’s largest trading partner – put increased pressure on the Reserve Bank of Australia (RBA) to further embark on its easing cycle.
Even though Standard and Poor’s retained a ‘stable’ outlook for the $1T economy, the agency warned of a possible downgrade ‘if Australia’s budgetary performance does not improve broadly,’ and went onto note that an ‘external shock’ may also put the rating under pressure as the region grapples with below-trend growth. Indeed, the slowdown in China may become a growing concern for Australian officials as the outlook for global growth deteriorates, and the RBA may adopt a more dovish tone over the coming months as Governor Glenn Stevens keeps the door open to further assist with the rebalancing of the real economy.
The fundamental developments coming out next week may spur a further decline in AUD/USD as Australia Building Approvals are projected to contract 1.0% in June, while the region’s Export Price Index is anticipated to contract another 4.0% in the second-quarter amid weak commodity prices paired with the downturn in global trade. At the same time, the fresh batch of central bank rhetoric coming out of the Federal Reserve’s July 29 interest rate decision may heighten the bearish outlook for AUD/USD as Chair Janet Yellen continues to talk up bets for a 2015 rate hike, and the policy divergence should foster a longer-term decline in the exchange rate especially if the committee shows a greater willingness for a September liftoff.
As a result, AUD/USD may continue to search for support throughout the last full-week of July, and the pair may ultimately give back the advance from back in 2008 as weakening growth prospects across the Asia/Pacific region fuels bets for lower borrowing-costs in Australia. In contrast, the greenback may continue to outperform against its major counterparts as the Fed stays on course to remove the zero-interest rate policy (ZIRP). - DS
New Zealand Dollar Looks to 4Q GDP, FOMC Outcome for Direction
Fundamental Forecast for the New Zealand Dollar: Neutral
New Zealand Dollar May Fall if Weak 4Q GDP Fuels RBNZ Rate Cut Bets
FOMC Meeting Outcome to Influence NZ Dollar via Risk Sentiment Trends
Identify Key Turning Points for the New Zealand Dollar with DailyFX SSI
The New Zealand Dollar managed to find support against its US counterpart after the RBNZ signaled it was in no hurry to cut interest rates at its monetary policy meeting. Governor Graeme Wheeler highlighted a range of factors underpinning strong economic growth and dismissed soft inflation readings in the near term as largely reflective of the transitory impact of oil prices. Speaking directly to the benchmark lending rate, Wheeler projected “a period of stability” ahead.
Still, the familiar refrainwarning that “future interest rate adjustments, either up or down, will depend on the emerging flow of economic data” was repeated. This makes for a news-sensitive environment going forward as markets attempt to divine the central bank’s likely trajectory alongside policymakers themselves. With that in mind, all eyes will be on the fourth-quarter GDP data set in the week ahead.
Output is expected to increase by 0.8 percent, an outcome in line with the trend average. On balance, that means a print in line with expectations is unlikely to drive a meaningful re-pricing of policy bets and thereby have little impact on the Kiwi. New Zealand economic data outcomes have increasingly underperformed relative to consensus forecast since January however. That suggests analysts are over-estimating the economy’s momentum, opening the door for a downside surprise. In this scenario, building interest rate hike speculation may push the currency downward.
The external landscape is likewise a factor. A significant correlation between NZDUSD and the S&P 500 (0.52 on 20-day percent change studies) hints the currency is sensitive to broad-based sentiment trends. That will come into play as the Federal Reserve delivers the outcome of the FOMC policy meeting, this time accompanying the statement with an updated set of economic forecasts and a press conference from Chair Janet Yellen. Fed tightening fears have proven to be a potent catalyst for risk aversion since the beginning of the month. That means a hawkish tone is likely to sink the Kiwi, while a dovish one may offer the currency a lift.