US Dollar Risks Major Bearish Reversal after Worst Drop in 4 Months
Fundamental Forecast for Dollar: Bullish
The USDollar dropped 0.9 percent this past week – its worst performance since the opening week of June
Market rate expectations are almost completely deflated, and a rebound in risk trends is more likely to revive speculation
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The Dollar suffered its worst stumble in four months this past week and technical traders recognize the unstable ground the currency currently stands on. The risk of a more critical break and move lower is palpable for a benchmark that has generally climbed for four years. Given the erosion in US rate forecasts and the flagging demand of haven assets – the fundamental pillars that lifted the Dollar to its current elevation – it would seem the ground is about to give way. However, the unique fundamental position the market has put the currency in will likely revive the bid before the bears are given room to run.
In the past six months, interest rate expectations have transitioned from charging the Dollar higher to anchoring congestion to sparking abrupt declines. At the beginning of the year, the clouds of QE3 were lifting and the conversation of rate forecasts teased rate watchers from a long hibernation. Through the first half of the year, a ‘mid-year’ hike left the Fed virtually unmatched for carry interest. As that loose deadline approached, the market began its current trend of discounting forecasts of a near-term move which in turn capped the currency’s climb. As of this past week, Fed Fund futures were pricing in an 8 percent chance of a hike on October 28 and 37 percent probability come December 16.
Going by the market’s estimate, the first quarter-percent increase isn’t entertained until June of next year. That leaves relatively little premium to further wick away from the Dollar’s forecast. To materially downgrade the Fed outlook from here, we would need to see will for a hike at any time in the future evaporate; and that is highly unlikely. More likely, the current level of skepticism is likely too high. The central bank has made a concerted effort to present a consistent voice to the market in order to acclimatize investors to an important transition ahead. According to their recent forecasts, we still have 13 of 17 FOMC members expecting a hike sometime this year and their rhetoric has not softened this level of conviction.
Heading into the new trading week, it will be important to assess the standing of rate speculation and establish its potential for change. Though there is little room to further deflate the market’s expectations, there is a considerable discount that can be retraced if the speculative ranks recognize the Fed is not backing down. Convincing speculators has proven difficult, however, so short of the policy meetings themselves; distinctive catalysts are needed. A range of Fed speeches is scheduled, but their consistency in warning of a nearer liftoff than traders account for only slowly works away at the incredulity. The scheduled consumer inflation figure (CPI) will carry a little more punch. A weak figure will likely just fold into current pricing while an uptick will tease a dollar bid.
Where deflated rate forecasts have pushed the Dollar to its current holding pattern, the next leg will likely find its impetus through general sentiment trends or weakened counterparts. The Dollar has enjoyed a modest haven premium over the past months, but we have not truly seen its safety appeal in full display – as is established by the lingering positive correlation to the S&P 500. If the troubles itemized by central banks, policy makers and investors (global growth, emerging markets, China) flare up; we will see the Dollar catch that bid. If they improve, justification for a delayed Fed hike will evaporate.
Perhaps the most active source of strength for the Greenback in the immediate future though is a weakened backdrop for its largest counterparts. This past week, we have seen the ECB warn of weaker inflation forecasts, the market bolster its expectations of a QQE upgrade for the BoJ in 2015 and the outlook for the BoE’s hike move the end of 2016. FX is a relative field. When the Dollar’s alternatives are looking at a neutral or outright dovish bias it reminds us that in the land of the blind, the one-eyed man in king.
Euro in Holding Pattern as Traders Await Clues on ECB’s Next Move
Fundamental Forecast for Euro:Neutral
- The worst US jobs report of 2015 briefly lifted EURUSD back above $1.1300 at the end of the week.
- The retail trading crowd retains a net-short position in EURUSD, offering a contrarian ‘bullish’ bias.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro endured a mostly quiet, choppy week of trading as the calendar turned into October and Q4’15, albeit with a general downward bias. Among the EUR-crosses, gains were limited in EURUSD (+0.19%) and EURGBP (+0.15%), while the rest of the pairs slipped only a shade more intensely. EURCAD (-1.22%) was the leader to the downside, followd by EURCHF (-0.63%) and EURNZD (-0.53%).
As expected, with the Euro holding its ground as a funding currency, it has been subject to gyrations in global bond and equity markets in recent days as well; the lack of significant movement over the week translated in a relatively quieter week than the once preceeding it. 1-week EURUSD historical volalility dropped to 5.79% as of October 2, down from 10.27% on September 25. Markets don’t think the volatility lull will last for that long, however, with 1-week EURUSD implied volatility up at 9.10%.
There may be some residual impact from the worst US Nonfarm Payrolls report of 2015 in the coming days, and a repricing of the Federal Reserve’s rate hike path against a backdrop of a weaker US economy will surely provoke larger swings in bonds, commodities, equities, and FX markets alike. However, beyond external influences, traders engaged in the EUR-crosses may not find that much to work with from the economic data side of things over the coming five days. The calendar is particularly light, with only Tuesday’s September PMI data piquing any interest.
In absence of a meaningful economic docket, traders may find the oft-overlooked ECB meeting minutes of greater interest this time around. The minutes will be released as speculation over when the ECB might ease next has heated up, perhaps simply as a response to the Fed keeping rates lower for longer or due to slumping inflation readings (the 5-year, 5-year inflation swaps closed down at 1.580%).
Ahead of the minutes, we already know that the ECB downgraded its growth and inflation forecasts for 2015 to 2017 at the corresponding meeting, which leads us to believe there was also likely a meaningful conversation on what to do should should growth and inflation readings disappoint. Along these lines, any color that can be discerned regarding the ECB’s future policy actions, for example, the path of the interest rate corridor or the prospect of expanding or lengthening the current QE program, could prove material to shaping rate expectations in the near-term.
Until markets pin down the likelihood of the ECB easing later this year or early next, the Euro is very much in a holding pattern. Reflexively, any prolonged period of Euro strength going forward probably raises the probability that the ECB will ease in the coming months, as a stronger trade-weighted Euro will only hurt exporters and dampen inflation. Rallies in the Euro still can draw some energy from a lingering net-short position held be speculators. The CFTC’s most recent COT report showed that speculators held 87.7K net-short contracts at the end of the week of September 29, 2015. Longer-term, however, positioning is not in the way of a further bulld up:traders were much more short in August (115.2K contracts) and in March (226.6K contracts). –CV
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USD/JPY Breakout Hinges on Sticky U.S. Inflation, Upbeat Fed
Fundamental Forecast for Yen:Neutral
The range-bound price action in USD/JPY may persist next week as the Bank of Japan (BoJ) continues to endorse a wait-and-see approach, but the fresh developments coming out of the world’s largest economy may trigger a topside break in the exchange rate should the data prints boost bets for a 2015 Fed rate hike.
Even though BoJ Governor Haruhiko Kuroda remains upbeat on the Japanese economy, the Cabinet Office Economic report may fuel expectations for additional monetary support as government officials call for another JPY 10T expansion in the asset-purchase program. With lingering expectations for a surprise move at the October 30 interest rate decision, increased pressure on the BoJ to further embark on its easing cycle may continue to foster a long-term bullish outlook for the dollar-yen amid the deviating paths for policy.
In contrast, with U.S. Retail Sales projected to increase another 0.2% in September, an uptick in the core Producer Price Index (PPI) accompanied by a sticky print for the core Consumer Price Index (CPI) may keep the Fed on course to normalize monetary policy later this year especially as Chair Janet Yellen argues that the disinflationary environment remains largely driven by ‘transitory’ factors. In turn, the Fed’s Beige Book may highlight an improved outlook across the 12-disctricts as the central bank continues to look for a stronger recovery, but the fresh comments from Fed officials may have a limited impact in shaping the outlook for monetary policy as the central bank remains ‘data dependent.’ Nevertheless, key speeches by Atlanta Fed President Dennis Lockhart, Chicago Fed President Charles Evans, Fed Governor Lael Brainard, St. Lois Fed President James Bullard, New York Fed President William Dudley and Cleveland Fed President Loretta Mester are likely to be in focus as market participants continue to gauge the Fed liftoff.
As a result, a slew of positive U.S. data prints paired with a batch of hawkish Fed rhetoric may boost the appeal of the greenback and threaten the range-bound price action in USD/JPY as it boost interest rate expectations. Meanwhile, the developments coming out of Japan may encourage bets for a more BoJ easing as the central bank keeps the door open to further insulate the economy.
BoE Strikes a Cautious Tone on Global Growth Concerns
Fundamental Forecast for British Pound:Neutral
The British Pound continues to trade with a mean-reversion tendency as prognostications around future rate hikes are becoming even more complex given the headwinds being seen by the global economy. We heard quite a bit about these headwinds at the most recent Bank of England rate decision, as the bank, once again, voted 8-1 to keep rates unchanged. The lone dissenter was, again, Mr. Ian McCafferty who had even voted to hike rates five times between August 2014 to December 2014; when there were no signs whatsoever of inflation within the British economy. At this point, we can safely label Mr. McCafferty a ‘hawk,’ but he’s outnumbered by a cautious Central Bank that wants to evaluate the economic situation on a global scale before kicking rates higher. The last rate hike from the Bank of England was in July of 2007 when the bank moved rates up to 5.75% before tempering them back down later in the year, beginning a cycle of low (and lower) rates that has yet to stop.
The head of the Bank, Mr. Mark Carney, called the current state of the global economy a ‘pretty unforgiving environment.’ Mr. Carney also went on to say that the timing of the BoE’s first move will not be dependent on the Federal Reserve as many have come to expect, and despite continued signs of recovery after upbeat British growth in the first half of the year slowed in the 3rd quarter, the bank’s rate decision should come ‘into sharper focus’ around the end of the year.
After seeing recent clues of inflationary pressure, primarily from wage growth, expectations for a BoE rate hike had begun creeping higher over the past two months. But as the circling troubles of China (and Asia), Emerging Markets and Commodity prices have thrown a wrench into global growth plans, expectations for inflation (and rate hikes) have been moving accordingly lower. Markets are now not pricing in a quarter-point rate hike until all the way out to 2017; and the Bank of England is expecting inflation to remain below one percent until spring of 2016, so there really isn’t any hurry to hike.
The Monetary Policy Committee will publish new inflation forecasts next month and this could provide direction for the Sterling should the bank push their expectation for a return to 2% inflation back to August of 2017. While this could equate to Sterling weakness, GBP/USD has to contend with a US Dollar that’s seeing a dramatic drop after the FOMC minutes showed another cautious Central Bank on the other side of the Atlantic.
The forecast for the Pound remains neutral for now, until a more defined fundamental direction can develop as the world grapples with slowing growth and a lackluster economy a full six years after the financial collapse. The UK and the BoE are one of the few spots other than the US that might be looking at higher rates in the not-too-distant future; but should matters change and should growth continue slowing, those expectations for higher rates will likely diminish and these currencies (both GBP and USD) could face massive weakness as rate-hike bets price out of the market.
Gold Prices Pivot Into Resistance- Breakout Potential on Dismal CPI
Fundamental Forecast for Gold:Neutral
Gold prices are firmer this week with the precious metal up 1.44% to trade at 1154 ahead of the New York close on Friday. The bulk of the advance came on Friday as the greenback struggled to hold its ground following the fresh batch of rhetoric coming out of the Federal Reserve.
Minutes from the September 17th FOMC policy decision highlighted greater concerns within the committee amid the ongoing disinflationary environment across the major industrialized economies paired with the slowdown in global growth. Despite the cautious tone, officials noted that it was ‘prudent’ to wait for further clarity on the economic outlook before adjusting policy with ‘many’ members still expecting to achieve liftoff later this year.
The remarks pushed stocks sharply higher while the dollar extended the decline from the previous week as expectations for an October Fed rate-hike continued to diminish. In turn, investors will be closely eyeing U.S. retail sales along with the key inflation reports on tap next week as the central bank argues that policy remains ‘data dependent.’ On the back of dismal September Non-Farm Payroll report, the inflation print will be of key importance with consensus estimates calling the core rate of consumer price inflation to remain steady at an annualized 1.8%. With the Dow Jones FXCM U.S.Dollar Index (ticker: USDOLLAR) marking its 4th consecutive day of losses on Friday, the greenback sits a key juncture as gold presses into a near-term resistance zone.
From a technical standpoint gold is set to close the week above the upper median-line parallel of a formation dating back to the 2014 high with Friday’s rally holding just below confluence resistance into 1159/62. This region is defined by the 61.8% extension off the yearly lows, the 100% extension off the September low & the Jun swing low. Note that the daily relative strength index is also testing a resistance trigger off the August high and a breach here alongside a rally through 1162 keeps the topside in focus targeting 1177 there the 200-day moving average & the median-line off the early low converge. Key resistance is seen high into 1197/98.The trade remains constructive near-term while above immediate support at the 10/2 reversal-day close / Friday’s low at 1138, with a break back below the monthly open at 1114 needed to shift the focus back to the short-side.
CAD Pushes Higher After Hitting 11yr Low, Still Oil Dependent
Fundamental Forecast for CAD: Bearish
Canada’s Consumer Price Index (CPI) expanded an annualized 1.3% in August, a marked slowdown in the core rate of inflation may dampen the appeal of the Loonie.
Oil Gains and a dovish rhetoric from the Federal Reserve have allowed the Canadian dollar to gain nearly one and a half percent against the USD.
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The Canadian Dollar witnessed a strong rise to end the week after a weak start. The Canadian dollar rebound is mainly due to bounces in commodities and risk that brought USDCAD lower by nearly 200 pips, and other Crosses display more CAD strength. Optimism currently surrounds the Trans-Pacific Partnership, or TPP agreement as Canada and Mexico signaled a willingness to open the North American auto market two parts made from ASEAN economies. However, the current question is whether or not the commodity and risk rally will last and for now the answer appears to be not long.
After a small beat in Canadian GDP, 0.8% vs. expectations of 0.7% last week, this week will bring us the Canadian unemployment rate. While the unemployment rate isn’t typically a trend changer, a definite surprise brings its fair share of volatility to CAD crosses.
From a relative basis, the Canadian dollar books most attractive against other resource exporting nations, such as Australia and New Zealand. However, an assumption of a continuing drop in commodity currencies, G4 FX may continue to attract capital on a haven capital flow play. On September 29, the Canadian dollar hit an 11 year low as USDCAD printed at 1.3457 against the US Dollar, and momentum could continue to carry this further still.
Currently, the correlation of commodity influenced currencies continues to drag down the entire bunch, which could continue to spell trouble for the Canadian dollar. Per the Bloomberg Commodity index, last quarter saw a 14% drop, the biggest since 2008 global financial crisis, and now eyes turned to a hawkish Federal Reserve that could further exasperate the move. Lastly, there is continued risk for political stalemates after next month’s national election that limits the fiscal stimulus to support the company aligning with an overreliance on oil for near-term direction.
Australian Dollar Rally May Stall on Jobs Data, US Inflation Uptick
Fundamental Forecast for the Australian Dollar: Neutral
Soft Employment Figures May Stoke On-Coming RBA Easing Speculation
US Core Inflation Uptick May Rekindle 2015 Fed Interest Rate Hike Bets
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On the domestic front, September’s Employment figures are in focus in the week ahead. Economists expect a 5,000 net increase in jobs, marking the smallest gain in three months. The unemployment rate is seen ticking up to 6.3 percent to match a six-month high.
Australian data outcomes have increasingly disappointed relative to consensus forecasts in recent weeks. This suggests analysts’ models are over-estimating the economy’s vigor, opening the door for more of the same ahead.
Last week’s RBA policy announcement maintained a familiarly neutral tone, offering no pre-established bias and stressing the data dependence of the central bank’s near-term outlook. Meanwhile, traders continue to price in at least one 25bps interest rate cut over the coming 12 months. A soft jobs reading may fuel speculation that easing will come relatively sooner versus later, weighing on the Aussie Dollar.
Externally, the evolution of bets on the likely timing of the first post-QE interest rate hike by the Federal Reserve remains in focus. Indeed, the Aussie’s ongoing eight-day winning streak - the longest in two years - is playing out alongside a downturn in front-end US bond yields and a rebound in the S&P 500 as a dovish shift in expectations feeds risk appetite.
September’s US CPI data stands out as an important inflection point in the debate among a range of noteworthy releases in the week ahead. Sluggish inflation has been at the heart of the Fed’s reluctance to begin stimulus withdrawal.
US price growth readings have firmed relative to analysts’ expectations since mid-year. If this trend continues and puts the core year-on-year CPI growth rate above 1.8 percent for the first time in 14 months, traders may begin to entertain calls for a 2015 rate hike championed by most Fed officials in recent commentary. This could trigger risk aversion, weighing on the sentiment-linked Australian unit.
NZD Ends Week on Positive Note After Fonterra Upgrades Forecast
Fundamental Forecast for the Kiwi:Neutral
New Zealand annual trade deficit widened to its largest margin since April 2009
Fonterra raised their milk payout forecast on Thursday giving NZD an end-of-week boost
For up-to-date and real-time analysis on the CAD, Oil and market reactions to economic factors currently ‘in the air,’ DailyFX on Demand can help.
New Zealand’s dairy industry accounts for roughly ~25% of the economy’s GDP. Because of this, the economy is highly sensitive to the direction of weekly payouts in dairy auctions and is intensely sensitive to the demand drop from China for imported dairy, which has contributed to the prices paid drop of 50%. This combination along with larger macro-economic risks aligned with the easing bias from the Reserve Bank of New Zealand, which has tracked the NZDs descent from mid-2014.
On Thursday, a report came out from Fonterra, the world’s largest dairy exporter that they were raising their forecast for milk payouts on an earnings jump in 2015. This development sent sentiment through the markets that the RBNZ’s easing stance may be too aggressive and therefore less inclined to cut rates in upcoming meetings. This mild but positive surprise for the Kiwi was most seen notably against commodity currencies.
The trade deficits were concerning in regards to the annual dairy exports as well as exports to China, one of the largest consumers of New Zealand products. Per the Statistics New Zealand, annual dairy exports fell by 25% to $11.99B NZD. Additionally, annual exports to China fell by 28% to $8.36B NZD.
Looking ahead, the markets have Building Permits for August as well as the ANZ Business Confidence report this week. Building permits will be gauged vs the prior reading of 20.4% and the Business Confidence index will look to rise from the dismal -29.1 reading last month. A tick up in either readings could carry the New Zealand dollar higher in a continuation of how it closed out last week.