Dollars Longest Run in Half a Century Hinges on Fed Decision
Dollar’s Longest Run in Half a Century Hinges on Fed Decision
Fundamental Forecast for Dollar:Neutral
The Fed is set Wednesday to Taper its QE3 further and release updated economic and interest rate forecasts
A FOMC effort to realign policy forecasts can cause set off for more than just Dollar volatility…
Find out what live events – such as the FOMC rate decision – are scheduled this week on the DailyFX Calendar
The US Dollar’s incredible climb was ramped this past week. The 1.2 percent surge from the Dow Jones FXCM Dollar Index (ticker = USDollar) was the largest in 10 months. The acceleration is just as impressive as the currency’s persistence. With Friday’s close, the greenback has closed nine consecutive weeks of advance. That is the longest advance on records going back to 1999 - when the Euro was introduced. Using the ICE Dollar Index’s extended history, a similar run shows that the nine-count matches the longest advances going back to 1967…nearly 50 years. Momentum looks self-sustaining, and few things seem as if they could curb this move much less reverse it decisively. But, it just so happens that one of the most capable fundamentals cues is dead ahead.
Wading through the most loaded global economic calendar in months – if not longer – it is the FOMC rate decision that takes top honors for potential market impact in terms of localized volatility as well as turning the tides of the entire financial markets. This particular meeting is expected to bring the second-to-last Taper by trimming it further down to $15 billion per month. However, that isn’t what the markets are holding their breath for. This gathering also happens to be the quarterly event whereby the central bank releases its updated forecasts on inflation, employment and interest rates as well as where Fed Chair Janet Yellen holds the regular press conference.
The tone that the central bank strikes with this meeting will prove critical to the dollar, one way or the other. A nine-week, 4.4 percent rally for the USDollar alongside a three-year high for US 2-year Treasury yields suggests market participants expect the central bank is gearing up for a near-term withdrawal of accommodation (conservative language for ‘rate hikes’). Therefore, if the Fed fails to upgrade its forecasts or in some way convey a more hawkish demeanor; there is pent up speculation that can be unwound.
On the other hand, the currency’s performance does not preclude room for further appreciation on the basis of an increased willingness to return to hikes. Looking out the yield curve, we still see skepticism and complacency. Perhaps the most prominent indication that there is pent up potential here are the Fed Funds futures. The rate products used to hedge changes in interest rates are significantly discounting the FOMC’s own forecasts. Where the last June forecasts projected a benchmark rate of 1.13 percent at the end of 2015 and 2.50 through the end of 2016, these futures currently price in 0.77 and 1.82 percent respectively.
Looking for changes in the forecasts and combing through the group’s verbiage, we should see whether the group is making a material effort to guide the market’s expectations. In the recent past, we have seen both FOMC members and research papers note that the market’s expectations for monetary policy are misaligned from the central bank’s own views. That poses a serious risk for policy officials as the eventual shift will prove more damaging to the stability of the financial system. Steady and measured adjustment is far preferable to a central banker. Efforts may be made to specifically close this gap.
While most FX traders will be gauging this event for its impact on the US Dollar, it will be important to remember just how substantial is scope is. The Fed’s stimulus efforts have played an early and pivotal role in establishing the low volatility, high leverage and low participation complacency conditions we find ourselves in today. If investors recognize a change in the financial landscape, the repercussions can prove far more pervasive than just a dollar correction. We may finally see complacency collapse. – JK
Euro Faces Volatility as External Factors Compound Onset of TLTRO
Fundamental Forecast for Euro: Neutral
Euro May Bounce on Strong Demand at First ECB TLTRO Operation
FOMC Announcement, Scotland Referendum May Stoke Euro Volatility
Help Identify Critical Turning Points for EUR/USD with DailyFX SSI
Euro selling pressure appears to be waning at last after eight consecutive weeks of losses that brought the single currency to the lowest level in 14 months against the US Dollar. The operative question going forward is whether this precedes a period of consolidation before a reinvigorated push downward or a correction upward. The answer will be found in the markets’ response to a hefty dose of high-profile event risk on the domestic and the external fronts in the week ahead.
Looking inward, thespotlight is on the first ECB TLTRO operation due to be held on September 18. The effort represents one of many easing tools that Mario Draghi and company have deployed in recent months in an attempt to check the slide toward deflation and repair the seemingly broken monetary policy transmission mechanism that has made the central bank’s prior attempts at stimulus largely ineffective. The scheme envisions offering Eurozone banks cheap capital tied up with conditions pushing them re-lend it while passing on low borrowing costs to the real economy, stoking activity and boosting prices.
The key variable in play will be the size of the liquidity provision that is ultimately taken up by banks tapping the facility. In a somewhat counter-intuitive turn of events, a large capital allocation seems likely to offer support to the Euro. The ECB has seemingly done everything it could muster in terms of expanding accommodative monetary policy without embarking on “classic” QE: the purchase of sovereign debt with newly minted money. Indeed, the TLTRO effort will be aided by a record-low baseline lending rate, a negative deposit rate, as well as purchases of asset-backed securities and covered bonds.
With that in mind, strong uptake on the TLTRO operation may be seen as giving policymakers a bit of breathing room to shift into wait-and-see mode without feeling pressure to do more, a move that could prove functionally difficult given strong opposition from the likes of Germany and undermine the ECB’s credibility. That may in turn fuel speculation that single currency has fallen substantially enough to price in the degree of easing already on the table, prompting a round of profit-taking on highly elevated speculative short positions and sending the common unit upward.
Externally, the first major item of note is the FOMC policy announcement. September’s outing will be accompanied by the release of an updated set of forecasts for key metrics of US economic activity as well as press conference from Chair Janet Yellen. The Fed has long warned about complacently buoyant risk appetite as the end of QE3 looms ahead next month. If policymakers opt to shake things loose with upbeat activity projections and/or a hawkish outing from Ms Yellen, this may put the Euro’s increasingly unattractive yield profile in stark relief and reinvigorate bearish momentum.
The second is the Scottish Independence referendum. Opinion polls ahead of the ballot essentially point to a 50/50 chance that Scotland will secede from the UK. This implies that – whatever the final result – a surge of volatility is likely to follow the results as those on the wrong side of the outcome are forced to readjust positions. A final vote in favor of independence is likely weigh on Sterling, sending capital fleeing to alternatives. The Euro looks like a natural beneficiary in such a scenario. Needless to say, a victory for the “no” campaign will probably yield the opposite result. – IS
Japanese Yen Remains Strong Sell Until these Factors Change
Japanese Yen Remains Strong Sell Until these Factors Change
Fundamental Forecast for Japanese Yen: Bearish
The Japanese Yen broke convincingly lower versus the US Dollar as the USDJPY set its single-largest weekly advance on the year. We believe the currency pair remains an attractive buy on the impressive break higher.
What drove the Yen and, more importantly, what may cause further volatility in the days and weeks ahead? Put simply: a divergence. On the one hand you have the Bank of Japan widely expected to ease monetary policy further through the end of the year. Across the Pacific Ocean, the US Federal Reserve is actually tightening monetary policy. The interest rate-sensitive USDJPY will likely track higher as the two central banks go in opposite directions.
The week ahead should prove particularly interesting given a highly-anticipated US Federal Open Market Committee monetary policy decision, while two planned speeches from BoJ Governor Kuroda could likewise drive USD/JPY volatility. Many traders expect FOMC officials will raise growth and employment forecasts and remove the key term “for a considerable time” from the future of interest rate hikes. Strong Dollar gains leave room for disappointment, but we think recent economic data supports calls for further tightening in monetary policy.
BoJ Governor Kuroda is comparatively less likely to force big moves in the USDJPY, but traders will pay close attention to any hints that the Japanese central bank will boost quantitative easing purchases through upcoming meetings. Note: unless he specifically says the BoJ will not do more QE, we believe a JPY bounce seems relatively unlikely.
The only caveat to our calls for continued USDJPY strength is simple: markets can’t go in one direction forever. It’s entirely possible and perhaps even likely that the Japanese Yen corrects higher (USDJPY lower) before its next major move. Yet remaining above key resistance-turned-support at ¥105.60 leaves us focused on continued USDJPY strength. - DR
--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.
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GBP/USD Vulnerable on Dovish BoE Minutes, Scotland Independence
Fundamental Forecast for Pound:Bearish
The British Pound is likely to face heavy volatility in the week ahead as the Bank of England (BoE) publishes the policy meeting minutes, while Scotland takes to the polls to vote for independence on September 18.
It seems as though we will see another 7-2 split within the Monetary Policy Committee (MPC) as Ben Broadbent and David Miles remain in no rush to normalize monetary policy, but the fresh batch of central bank rhetoric may continue to prop up interest rate expectations as Governor Mark Carney retains an upbeat view for the U.K. economy. Despite the risk of Scotland leaving the U.K., it seems as though the central bank will retain its game plan to normalize monetary policy as Mr. Carney sees the first rate hike coming in the Spring of 2015, and a more upbeat tone from the MPC may generate a larger recovery in the British Pound as the BoE moves away from its easing cycle.
At the same time, the Federal Open Market Committee (FOMC) policy meeting will also be closely watched as Janet Yellen and Co. look to halt its asset-purchase program in October, but we would need to see a material shift in the forward-guidance to see a major market reaction as the central bank remains reluctant to move away from the zero-interest rate policy (ZIRP).
With that said, the Scottish Referendum holds the biggest risk for surprise as independent polls continue to highlight the threat for a breakup, and the outcome is likely to have a material impact on the near-term outlook for the GBP/USD as a departure from the monetary union may spark a material shift in the policy outlook.
Nevertheless, there are tentative signs of a more meaningful rebound in the GBP/USD as the Relative Strength Index (RSI) comes off of oversold territory, but we would need to see a break of the bearish momentum along with a move and closing price above former support (1.6280-1.6300) to favor a more bullish outlook for the pound-dollar. - DS
Gold Plummets to Eight-Month Lows on Persistent USD - All Eyes on FOMC
Fundamental Forecast for Gold:Bearish
Gold prices are markedly lower this week with the precious metal off by more than 3% to trade at $1229 ahead of the New York close on Friday. The losses come amid continued strength in the greenback with the Dow Jones FXCM US Dollar Index pressing into fresh yearly highs not seen since August of 2013. While the broader outlook for gold remains weighted to the downside, near-term the metal is coming into support as investors shift their focus to next week’s key event risk from the Fed.
Easing geopolitical tensions in Ukraine, persistent strength in the dollar and improving US economic data has continued to weigh on demand for gold as prices fell to eight month lows this week. Looking ahead to next week, all eyes will be on the Federal Reserve on Wednesday with the August inflation numbers and the FOMC rate on tap. Should the policy statement cite a more upbeat assessment for growth and inflation, look for gold to remain under pressure as interest rate expectations keep a firm footing under the greenback. Such a scenario would likely see US Dollar denominated assets slide as US Treasury rates move higher.
On the other hand, should committee members cite skepticism or concerns over the recent miss seen in last week’s dismal non-farm payroll print, bullion could find some near-term demand/profit taking, with prices checking a key support barrier on Friday before retreating higher. As we’ve continued to note, the most significant possible supportive variable / risk to our outlook for gold “would be a more substantial sell-off in stocks or sudden escalations in geopolitical tensions both in Europe or the Middle East with such a scenario likely to fuel risk-off flows into the perceived safety of the yellow metal. That said, the technical picture remains rather bleak.”
From a technical standpoint, the outlook for gold remains weighted to the downside with our bearish invalidation level now brought down to 1258/60. A breach above this level shifts the focus back to the topside targeting key resistance at $1280/82 and the 200-day moving average at $1286. Near-term support rests at the 76.4% retracement taken from the late-December advance at $1229 with a break below targeting support objectives at $1206 and $1193. Note that the daily momentum signature has now dropped to its lowest levels since early June when the metal based around the $1243 with the drop into oversold territory this week suggesting that a larger decline off the July highs remain in focus. Look for Wednesday’s event risk to offer a catalyst with our broader bias favoring selling rallies sub $1260. -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 Remains at Risk as the Return of Volatility Caps Carry Demand
Fundamental Forecast for Australian Dollar: Bearish
AUD/USD Downside Risks Remain Following Break of Long-Held Range
Surge In Implied Volatility Threatens To Sap Carry Trade Demand
Bearish Technical Pattern Casts The Spotlight On 90 US Cents
The dam wall may have finally broken for the Australian Dollar following the currency’s plunge below the 92 US cent handle. The long-held line in the sand for the AUD/USD was crossed amid a parabolic increase in FX market volatility and firming Fed policy tightening bets.
Over the coming week, a void of major local economic data alongside what is likely to be another rehashed set of RBA Minutes may leave the currency lacking catalysts to spark a recovery. The threshold for fresh news flow to yield a shift in sentiment is high, as demonstrated by the lackluster response from traders to the phenomenal Australian August jobs report.
On balance recent local data and rhetoric from the Reserve Bank reinforces the prospect that rates will remain on hold over the near-term. Yet the greatest risk posed to the Aussie is not from a shift in RBA policy expectations and a waning of its interest rate advantage. Rather the bigger threat has proven to be the looming return of general market volatility.
A persistent surge in expectations for large swings amongst the major currencies would make the Aussie’s relatively small yield advantage a much less attractive (and riskier) proposition. This may open the door to a mass exodus from carry trades that had built on anticipation of a sustained lull in market activity. Long positioning amongst speculators is at its highest since April 2013 according to futures data. Which suggests that once the floodgates open, they may be difficult to close.
From a technical standpoint the break of the 92 US cent handle and ‘head and shoulders’ pattern ‘neckline’ casts the spotlight on the psychologically-significant 0.9000 floor. - DDF
Refer to the US Dollar outlook for insights into how the USD side of the equation may influence the AUD/USD pair.
NZDUSD to Face Larger Rebound If RBNZ Removes Verbal Intervention
Fundamental Forecast for New Zealand Dollar: Neutral
The Reserve Bank of New Zealand (RBNZ) policy meeting on September 10 may heighten the bearish sentiment surrounding NZD/USD should the fresh batch of central bank rhetoric drag on interest rate expectations.
According to a Bloomberg News survey, all of the 12 economists polled forecast the RBNZ to keep the benchmark interest rate steady at 3.50% as Governor Graeme Wheeler adopts a neutral tone for monetary policy, and the New Zealand dollar may face a further decline in the days ahead if the central bank head sees a period of interest rate stability throughout the remainder of 2014. At the same time, Governor Wheeler may continue to highlight weaker commodity prices to favor a weakened outlook for the New Zealand dollar, but the recent slide in the higher-yielding currency may raise the outlook for price growth as it draws imported inflation.
With that said and given the near-term decline in NZD/USD, the biggest risk surrounding the RBNZ interest rate decision will be a removal of the verbal intervention on the kiwi as the central bank sees a more sustainable recovery in New Zealand. As a result, Credit Suisse Overnight Index Swaps continue to show expectations for at least one 25bp rate hike over the next 12-months, but dovish remarks from the RBNZ may push NZD/USD to give back the rally from the February low (0.8050) as market participants scale back bets for higher borrowing costs.
Nevertheless, the 0.8250-60 region remains the next key level of interest as NZD/USD retains the descending channel along with the downward trend in the Relative Strength Index (RSI), but a lack of jawboning from the RBNZ may foster a more meaningful recovery in the New Zealand dollar as the oscillator comes off of oversold territory.