Dollar and the Markets Contemplate Volatility and QE
Fundamental Forecast for Dollar:Bullish
Risk trends remain the top priority this week, but the deciding factor is conviction
The Fed’s Bullard stirred hope for a QE Taper delay, but that is unlikely and exposes ‘hope’
See the fundamental and technical forecast for the USDollar in our updated 4Q Forecast Trading Guide
Amid extreme financial market volatility swings and talk of US stimulus plans, the US Dollar finished out a second consecutive week in the red. Yet, despite the past few weeks retreat, the currency’s larger three-month bull trend is still dominating the landscape. That technical view matches the fundamental backdrop. While there have been a few headlines and updates to cool the Dollar’s exceptional climb, there hasn’t been enough of turn the tides back towards the bear’s favor. Moving forward, the anxiety of a fragile gobal investor sentiment, a reinforced path of monetary policy and a possible second wave decline for the the Greenback’s largest counterparts will all support the currency’s medium-term view.
When liquidity returns next week, the first concern for market participants will be the bearings for broader sentiment. Investor confidence passed through two stages this past week. The first half was dominated by heavy selling in capital market assets that confirmed an important break that ended the previous week. Yet through the second half, a rebound for the higher return / higher risk segment and retreate for safe havens developed. In fact, through this heavy swing in confidence, the US currency never seemed to truly find grip through its safe haven status.
There is a difference between an unfavorable move in capital markets and a motivated ‘risk unwind’. The latter speaks to conviction and a motivation that is more elemental to the financial system. After a five-and-a-half year climb from the bottom of the worst economic and financial collapse in generations, it is difficult to unmoor complacency and convince market participants to cut exposure and feed speculative shorts. Yet, the recent scope of selling riskier assets and the tremendous rise in implied (expected) volatility herald a more motivated shift is building. Against record leverage, decades low participation and a cooling economic backdrop; investors are increasingly aware of the medium-term gap between price and value.
As the motivation shifts from a modest ‘risk off’ to a more systematic deleveraging, liquidity becomes the primary concern for market participants. That leverages demand for US Treasury, money markets and the Dollar itself. It may take time to reach this intensity, but implications are acute and the structural deficiencies to our current situation large enough that it planning is important. As we await the mass’s verdict on the market’s course and potential, a few other factors should be considered while trading the Dollar. The first consideration is a recent flush of hope that the Fed could backtrack on its tightening regimen.
This past week, St. Louis Fed President James Bullard – not a voter this year and more on the hawkish side with a recent call for a 1Q 2015 rate hike – turned heads when he suggested the FOMC should consider delaying its final Taper of QE3. His suggestion is more targeted towards tepid inflation, but the market in withdrawal and desperate for support reads it as a capital market boon. Realistically though, this isn’t a popular opinion and the Yellen sounded very confident of an October 29 final move at the last meeting. Furthermore, delaying a few months a scaled down stimulus isnt’ the same as an increase for encouraging risk trends. We will see little more on this topic with the media blackout period coming ahead of the next meeting.
A final consideration for those trading the Majors: counterpart activity. This past week’s shudder in risk has clearly exposed the Euro-area’s troubles. Whether a trigger for global risk aversion or a direct counterbalance for the Dollar, this has considerable potential. We also have Chinese and UK 3Q GDP data on tap. – JK
Euro Faces Economic Headwinds with Weakening German, Euro-Zone PMIs
Fundamental Forecast for Pound:Neutral
- The Euro may have its own problems, but it may be able to lever the US Dollar’s moment of vulnerability.
- The retail crowd’s shift in the US Dollar is led by what could be a bottom forming in EURUSD led by sentiment.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro broadly stabilized for the second straight week, posting a +1.09% gain against the US Dollar, with the EURUSD exchange rate closing at $1.2761 on Friday. The 18-member currency gained against all but two of the other seven major currencies, with minor gains rewarded to the Swiss Franc (EURCHF -0.09%) and the New Zealand Dollar (EURNZD -0.31%). Concerns over the region’s growth prospects continue to linger, but they haven’t produced further downside yet in the Euro.
Although economic conditions have moved off the low, the Euro-Zone remains in an economic state on the verge of its third recession since the financial crisis began in 2008. The Citi Economic Surprise Index closed the week at -54.1, barely off the yearly low established on October 14 at -57.3.
The big concern levied by market participants that’s holding back the Euro is the ongoing pressure in medium-term inflation expectations. The 5Y5Y breakeven inflation swap, the European Central Bank’s preferred market measure of medium-term inflation expectations, slumped to a new yearly low this week before rebounding sharply. The gauge fell as low as 1.541% on Wednesday but closed the week at 1.779%.
What’s particularly interesting about this recent mix of financial and economic conditions is that the Euro hasn’t been depreciating. EURUSD is nearly 300-pips off of its early-October low, and the futures market remains saturated with aggressively short speculators. Non-commercials/specs held 155.3K net-short contracts for the week ended October 14, an increase from the 146.2K net-short contracts held a week earlier. Still, market positioning is off its extreme seen in early-September, when specs held 161.4K net-short contracts.
There is latent potential, then, if the Euro is braving weakening conditions and a buildup of short positions, for a short covering rally. One could develop as the US Dollar faces its own moment of vulnerability, or if incoming economic data doesn’t disappoint market expectations too greatly. The week is packed with typically market-moving PMI releases. Overall, further weakness is anticipated in the broader Euro-Zone indicators due to drag originating out of France and Germany.
The scope of the incoming recession to the Euro-Zone’s largest economy will be in particular focus, as the preliminary October German Manufacturing PMI is expected to decrease further to 49.6, indicating a heightened pace of contraction. The weak reading should reflect not only weakening domestic demand but also softer foreign demand, from Euro-Zone and emerging market partners alike. This means that any economic weakness forthcoming may be beyond the current scope of the ECB’s measures.
If the table is getting set for a Fed-styled, sovereign QE program to bolster the ECB’s easing stance, then that too will have to wait: the market is eagerly awaiting the ECB to release the results of the asset quality review (AQR) on Sunday. –CV
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Japanese Yen To Extend Gains on Global Slowdown, Fed Tightening Fears
Fundamental Forecast for Japanese Yen: Bullish
Soft Eurozone and Chinese Data, Strong US CPI to Fuel Risk Aversion
Yen to Extend Gains as Carry Trades Unwind Amid Slump in Sentiment
Help Identify Critical Turning Points for USD/JPY Using DailyFX SSI
A lull in homegrown event risk will keep macro-level trends in focus for the Japanese Yen in the week ahead. The inverse correlation between the currency’s average value against its leading counterparts and the MSCI World Stock Index – a proxy for market-wide risk appetite – now stands at a hefty -0.72 (on 20-day percent change studies). That puts the Yen firmly into the “safety” side of the risk on/off asset spectrum and hints the currency stands to recover further as sentiment continues to sour.
The central concern preoccupying investors is the ability of a resurgent US economy to underpin global growth, offsetting weakness in China and the Eurozone even as the Federal Reserve prepares to wind down the QE3 stimulus program later this month. A steady stream of high-profile economic data releases will help inform this debate in the week ahead, generating volatility for underlying risk sentiment trends and with them the Japanese Yen.
In China, the third-quarter GDP figure is in the spotlight. Consensus forecasts put the year-on-year growth rate at 7.2 percent, marking the weakest reading since the post-crisis trough in the first quarter of 2009. Economic news-flow from the East Asian giant has increasingly deteriorated relative to expectations since mid-August (according to data from Citigroup). That suggests analysts are underestimating the degree of the unfolding downturn and warns that the realized GDP print may be even more dismal than forecasts imply.
Turning to the Euro area, the preliminary set of October’s PMI figures is due to show the pace of manufacturing- and service-sector activity growth slowed for a third consecutive month, yielding the weakest results in 14 months. Adding insult to injury, the ECB seems resigned to complacency. Financial conditions in the region have deteriorated since mid-September even as the central bank introduced negative deposit rates and conducted its first TLTRO operation. In response, ECB officials have counter-intuitively used public speaking opportunities to play down expectations for the upcoming asset purchase program.
Finally, the US data docket is headlined by September’s CPI report. The headline year-on-year inflation rate is expected to slow to 1.6 percent, the lowest since March. However, leading survey data warns that price growth accelerated, with factory-gate prices rising at the sharpest pace yet in 2014 and service-sector output costs reaching a five-month high. That opens the door for an upside surprise, which would help rebuild 2015 Fed rate hike expectations. The prospect of tightening in one of the world’s three main growth hubs even as the other two decelerate bodes ill for risk appetite, amplifying liquidation of Yen-funded carry trades and helping the Japanese unit upward.
GBP/USD Rebound Vulnerable to Dovish BoE Minutes, Slowing 3Q U.K. GDP
Fundamental Forecast for Pound:Neutral
The British Pound may face additional headwinds in the week ahead should the fundamental developments coming out of the U.K. drag on interest rate expectations.
Indeed, Bank of England (BoE) Chief Economist Andrew Haldane warned ‘interest rates could remain lower for longer’ amid the uncertainly surrounding the economic outlook, and the central bank may look to preserve the highly accommodative policy stance for an extended period of time especially as the Euro-Zone, the U.K.’s largest trading partner, faces a growing risk of slipping back into recession.
As a result, the BoE Minutes are widely expected to show another 7-2 split, with Martin Weale and Ian McCafferty still voting against the majority, but the policy statement may highlight a more dovish tone for monetary policy as the headline reading for U.K. inflation slows to an annualized 1.2% in September to mark the lowest reading since 2009. At the same time, the 3Q Gross Domestic Product (GDP) report may undermine the BoE’s expectations for a faster recovery as the growth rate is projected to expand 0.7% after rising 0.9% during the three-months through June, and a marked slowdown in the real economy may generate fresh monthly lows in GBP/USD as market participants scale back bets of seeing higher borrowing costs in the U.K.
Nevertheless, the technical outlook highlights a more meaningful recovery for GBP/USD as the Relative Strength Index (RSI) breaks out of the bearish momentum carried over from the end of June, and we will continue to keep a close eye on the ongoing divergence in the oscillator amid the string of lower highs in price. - DS
Gold Rally at Risk Amid Sticky US Inflation- $1222 Key Support
Fundamental Forecast for Gold:Neutral
Gold prices pushed higher for a second consecutive week with the precious metal rallying 1.27% to trade at $1238 ahead of the New York close on Friday. The advance comes amid continued weakness in broader risk assets with all three major US indices down for a fourth consecutive week. Despite the risk-off environment, the key developments coming out of the U.S. economy may heavily impact gold prices next week after prices rebounded off key technical resistance mid-week.
Federal Reserve speakers have continued their Dovish rhetoric as the FOMC eyes the overwhelming disinflationary risks associated with a premature rate lift-off. Indeed, St. Louis Fed President James Bullard, who won’t be a voting member on the FOMC until 2016, undermined the bullish sentiment surrounding the U.S. dollar as the policymaker saw scope to extend the QE exit and we may see a growing number of central bank officials show a greater willingness to retain the highly accommodative policy stance for an extended period of time amid the subdued outlook for inflation.
As a result, the September consumer price index will largely be in focus next week, with consensus estimates calling for an uptick in the core reading to 1.8% y/y from a previous read of 1.7% y/y while the headline print is expected to downtick from 1.7% y/y to 1.6% y/y. With weakening energy prices, market participants may pay closer attention to the stickiness in core inflation as FOMC voting member Charles Plosser sees scope to normalize policy sooner rather than later.
From a technical standpoint, gold tested and defended a key resistance level noted in last week’s update at $1243/44. This region is defined by the 38.2% retracement off the July high, the June close low and is the confluence of two pitchfork resistance lines. Although the broader outlook for gold remains weighted to the downside, we cannot rule out continued strength into the monthly close on account of the monthly opening range break which was validated this week. Bottom line: near-term the trade remains constructive while above $1222 with only a break sub-$1206 putting the bears back in control. A breach above $1244 eyes more significant resistance at $1260/63 and $1283 where ultimately we would start looking for favorable short entries. - MB
Canadian Dollar Faces Conflicting Cues from BOC, Key US Data
Fundamental Forecast for Canadian Dollar: Neutral
Canadian Dollar May Extend Advance on a Hawkish BOC Tone Shift
Upbeat US Data May Fuel Fed Rate Hike Bets, Undermining Loonie
Help Identify Critical Turning Points for USD/CAD with DailyFX SSI
Last week marked an important turning point for the Canadian Dollar, with prices reversing sharply higher after hitting the weakest level in almost four months near 1.10 against the currency’s US counterpart. The surge gathered momentum after US-based Burger King Worldwide Inc said it will buy Canada’s Tim Hortons Inc for US$11 billion, implying on-coming M&A capital flows favoring the Loonie in the pipeline. The deal’s supportive implications appeared to run deeper however. The news-wires narrative framed the transaction as a poster-child for a broader “inversion” trend, wherein US firms re-domicile abroad to take advantage of favorable tax policies.
While the latest price action demonstrates that M&A considerations are to be respected, their ability to fuel continued Canadian Dollar gains without support from baseline fundamentals seems inherently limited. With that in mind, the outcome of next week’s Bank of Canada (BOC) monetary policy announcement stands out as critical, with the outcome likely to prove formative for the Loonie’s direction in the near term. The last policy announcement in mid-July leaned on the dovish side of the spectrum, with the bank trimming its outlook for growth and establishing a longer timeline for the economy to reach full capacity. A building mound of evidence suggests Governor Steven Poloz and company may opt for a different approach this time around.
As if by design, Canadian economic news-flow began to dramatically improve relative to consensus forecasts on the very same day as the BOC issued July’s policy statement, with a Citigroup gauge showing realized data outcomes are outperforming expectations by the widest margin in 14 months. External developments have likewise proved supportive. July’s announcement stressed that Canada’s recovery “hinges critically on stronger exports”. This underscored the vital significance of a pickup in US demand, which accounts for close to 80 percent of cross-border sales. On this front, the landscape looks far rosier today than it did six weeks ago, with a run of supportive US releases suggesting the world’s largest economy is truly on the mend after a dismal first quarter. The Canadian Dollar may find a potent upside catalyst if these considerations bleed into the tone of the statement accompanying the BOC rate decision.
Looking beyond home-grown factors to macro-level considerations, the key theme still in play is the length of the expected time gap between the end of the Federal Reserve’s “QE3” stimulus effort in October and the first subsequent interest rate hike. Next week’s calendar offers plenty of inflection points to drive speculation. Manufacturing and service-sector ISM readings, the Fed’s Beige Book survey of regional economic conditions and the obsessively monitored Employment report headline scheduled event risk. Persisting strength in US data outcomes is likely to drive speculation that the FOMC will not wait very long before beginning to actively withdraw stimulus. If this triggers a one-sided surge in the US Dollar against its leading counterparts, the Loonie is unlikely to go unscathed.
AUD Faces Further Swings On Market Jitters, Q3 Inflation, & China GDP
The Aussie may be in store for another wild week with shifts in general market sentiment, local CPI figures and top-tier Chinese data to offer the currency guidance.
Fundamental Forecast for Australian Dollar: Neutral
AUD/USD Swings Wildly In Intraday Trade On Investor Sentiment Shifts
Regional Economic Data To Offer Limited Guidance Amid Steadfast RBA Bets
Surge In Volatility and Investor Jitters May Keep Pressure On The AUD
The Australian Dollar had another rollercoaster week against its peers as shifts in global risk sentiment swung the high-yielding currency wildly during intraday trade. Meanwhile, medium-tier regional economic data saw a lackluster response from the AUD amid well-anchored RBA policy bets.
Looking to the week ahead, Q3 CPI figures headline the Australian economic calendar. Another deviation from expectations holds the potential to catalyze knee-jerk volatility for the currency. Yet follow-through is likely to prove difficult given it would take a significant surprise to materially alter rate expectations.
Meanwhile, the RBA’s October Meeting Minutes and a speech from Governor Stevens (focused on the Australian payments system) are unlikely to offer fresh insights into policy makers’ thinking. In turn these may prove uneventful for the AUD.
Elsewhere in the region, a raft of top-tier economic data from China is on the docket. The figures from the Asian giant could do little to dent steadfast Reserve Bank bets. Yet disappointing data from the world’s second largest economy may have the potential to feed mounting concerns over global growth and fan risk-aversion, which in turn would be a negative for the Aussie.
The primary threat to the high-yielding currency remains the prospect of a continued surge in volatility, which according to some measures is at its highest since February. While many Aussie carry trades may have already been unwound short positioning in the futures markets remains well off the extremes of last year. This suggests there is plenty of room in the short trade before it begins to look ‘crowded’.
Sellers appear intent on keeping the AUD/USD capped below the 89 US cent handle, leaving the risk focused on the 0.8660 barrier for the pair. If broken on a ‘daily close’ basis it could open the next leg lower to the July 2010 low near 0.8320. For more on the US Dollar side of the equation read the weekly forecast here.
New Zealand Dollar at the Mercy of Market-Wide Sentiment Trends
Fundamental Forecast for New Zealand Dollar: Neutral
NZ Dollar at the Mercy of Risk Trends Amid Lull in Domestic News Flow
Global Growth Fears and Ending Fed Stimulus Put Sentiment at Risk
Help Identify Critical Turning Points for NZD/USD Using DailyFX SSI
A quiet economic calendar on the domestic front is likely to see the New Zealand Dollar price action fall in with broad-based risk appetite trends in the week ahead. That probably spells volatility for the sentiment-geared currency as heretofore complacent investors begin to see a perfect storm of risk aversion gathering on the horizon.
The markets appeared to be taking the approaching end of the Federal Reserve’s QE3 asset purchase program in stride until relatively recently. While the swell in risk-geared assets has been closely linked with the US central bank’s generous stimulus efforts, traders seemed content enough with the post-Q1 recovery in US economic news-flow to believe that asset prices need not necessarily unravel after liquidity injections are wound down.
This relative calm appears to be giving way as policymakers from seemingly all directions sound the alarm about “frothy” valuations while global growth bets fizzle. Fears of another recession in Europe coupled with a deep slowdown in China had been somewhat muted amid hopes that a robust US would amount to a strong-enough countervailing force. Such rosy notions were notably upset last week as minutes from September’s FOMC meeting revealed concerns about contagion.
The churn continues in the week ahead. In the US, speculation about the length of the time gap between the end of QE3 and the first subsequent rate hike will be informed by September’s PPI data. On the growth front, Retail Sales and Industrial Production figures as well as the Fed’s Beige Book survey of regional economic conditions will help inform bets on whether the US is strong enough to hold up global demand as output elsewhere falters.
Meanwhile, a Chinese Trade Balance and CPI readings will help to gauge just how deep of a slump is developing in the East Asian giant and what might be done about it. The inflation gauge seems like it might draw particular attention, with a softer print likely to be seen as opening the door for Beijing to expand policy support, and vice versa.
On balance, the path of least resistance seems to favor risk aversion. It seems altogether naïve to think that risky assets will happily resume a steady advance even as the Fed withdraws its helping hand and growth forecasts are roundly slashed. Timing such reversals is notoriously difficult however, and it remains unclear if the week ahead will ultimately deliver the seemingly inevitable breakdown. A bout of volatility is almost surely in the cards however, with swings risk appetite set to be mirrored in Kiwi performance.