US Rate Speculation Versus a Tumultuous World of Fundamentals
Fundamental Forecast for Dollar: Bullish
A slew of Fed speeches and November NFPs will pilot rate expectations that already see a 78% chance of a Dec hike
The greater fundamentals winds may come from the Dollar’s peers amid a round of rate decisions and SDR status checks
See how retail traders are positioning in the majors in your charts using the FXCM SSI snapshot
The week ahead is the antithesis of what we have come to expect from December. Seasonal studies say the month is historically a quiet one with a quiet build in risk appetite. Instead, we are heading into the first wave of a significant fundamental assault that will test already flimsy speculative forecasts while running a high risk of volatility. The question immediately on most FX traders’ minds is whether the standings of monetary policy biases shaped over the past few months will hold their course. Yet, participants of all markets should be more concerned over the implications of volatility against thin volume and a leveraged speculative exposure. These are circumstances ripe for liquidity problems and a dramatic shift in both market direction and pace.
It is natural for traders confronted with a wide docket of event risk and fundamental uncertainty to hone in on what they perceive to be the most market-moving potential spark and set their strategy and expectations from there. That would be a mistake if we were trading the Dollar this week. The favored indicator on the calendar ahead is the November NFPs (nonfarm payrolls) and its supporting cast of labor statistics. This data is certainly important. Relative monetary policy has been one of the most productive and constant fundamental themes in the currency market. NFPs is the last major statistic with a direct bead on policy that is scheduled to be released before the December 16 rate decision.
That said, the market is already well-prepared for the disparate bearing from the US currency. Where six weeks ago, Fed Fund futures were pricing in around 6 percent probability of a Fed hike before the end of the year; now same instrument shows hedgers set the chances at 78 percent. Where that leaves plenty of room to lift or lower the stakes, the reality is that the Fed – and thereby the Dollar – is in a unique position to tighten in a definable timeline where most other are proactively easing or neutral. In the data breakdown, the actual payrolls and unemployment rate will carry less weight than the participation and average earnings figures. Wages in particular will be meaningful as it reflects the missing piece of the monetary policy puzzle: inflation.
If the Dollar is to find its next leg higher or meaningfully lose ground to its counterparts, the true focus will turn to the ‘pace’ from the FOMC. Where this has been a common warning by policy officials for months, most speculators have obsesses over the timing of the first hike (likely making them eager to get it out of the way). Yet, after ‘liftoff’, projecting the second, third, fourth and so on increases will be more important for developing extended values. A number of Fed member discussions scheduled this week will likely help shape that forecast. Chairwoman Janet Yellen is set to testify between the Joint Economic Committee in Congress; but I’m more interested in Fed Brainard’s speech on neutral rates, Mester and Fischer’s talks on financial stability, Bullard’s remarks on the ‘new normal’ and Kocherlakota’s views on ‘renormalization’.
Reminding us that there are deeper currents to the market than just the Fed’s first move to normalize reminds us that eventually monetary policy will shift across the world. And, that time may be closer than investors are prepared for especially with the exceptional amount of risk they are balancing. That risk and the imminence of a retracted global central bank safety net will also bubble to the surface with other, major global event risk. Policy decisions by the ECB, RBA, BoC and RBI; GDP updates in the developed and developing world; and China’s SDR status are just a few major events that can give indirect USD influence and change the global financial system’s current.
EUR/USD Prepares for its Most Important Week in Months (If Not Years!)
Fundamental Forecast for EUR/USD: Neutral
- Data during the holiday-shortened week was generally constructive for EUR/USD losses.
- The retail crowd recently started buying Euros, turning the sentiment forecast bearish.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
Euro rates were mixed during the holiday-shortened week, as traders and investors alike prepared for what should be the most important week in years for the Euro, but especially EUR/USD. EUR/USD was the weakest EUR-cross, losing -0.45% to $1.0589, while EUR/GBP was the strongest, edging up by +0.69% to £0.7046. Markets have proven jitterier on approach to the December 3 European Central Bank as the outlook for what Draghi & co. might do has become both more transparent and opaque at the same time.
In some regards, the market has effectively priced in the first half of expected easing from the ECB: a cut to the deposit rate. This may have been priced in starting on October 22, when President Mario Draghi suggested that rates had not reached their lower bound – a remark that cut against the entire market’s understanding of potential ECB policy outcomes. This development garnered a significant negative reaction by the market on October 22, when EUR/USD saw a sharp >200-pip decline, mirroring the reaction in price on September 4, 2014, when the pair fell by -206-pips after the ECB announced a surprise cut to the deposit rate. So, if a deposit rate cut is coming on Thursday, the market may have already effectively priced it in (and then some): EUR/USD dropped from near $1.1350 ahead of the October 22 meeting to a closing low of $1.0589 this week.
In no uncertain terms, as ECB policymakers have talked up the high likelihood of a rate cut on Thursday, they have also in turn failed to provide any clarity – hence policy become more opaque as well – as to what they intend on doing with their QE program. While a lot of EUR/USD’s decline over the past month has to do with markets pricing in the Federal Reserve raising rates on December, it also has been fueled by speculation that the ECB will announce some form of enhancement to the QE program: an increase in the program’s duration, an increase in the run-rate of asset purchases, and/or an expanded universe for accepted collateral.
In light of the fact that markets beyond FX have started to behave in a manner that indicates positioning front-running. Yields across Europe, not just in the Euro-Zone, have plummeted once again (but also in the Euro-Zone, too). For a time this week, yields out to seven years were negative in Germany, and yields out to 14 years were negative in Switzerland. Purchasing debt with these yields indicates that the investor would actually have to pay these governments; which means those purchasing these bonds are most likely betting on capital appreciation. In order for these bond prices to go higher and thus yields lower, the ECB would have to be behind a significant dovish shift in policy to prevent a backing-up of yields, similar to what happened in May this year.
At this point in time, a deposit rate cut is most likely priced in, as is one of our identified three enhancements to the QE program. If the ECB is able to deliver more than this, EUR/USD as do all EUR-crosses have a strong chance of continuing lower. Yet, in what is the more likely outcome now that Euro-Zone economic data ex-inflation is continuing to improve (the Euro-Zone PMI readings just hit four-year highs), the ECB will choose not to waste the bullets left in its chamber and instead leave open the possibility for more easing in the future. If downgrades are prevalent in the latest staff projections, these may act as a cap to potential short covering in the Euro complex.
Given the trifecta of major events at the end of the week – the ECB’s last policy meeting of 2015 on Thursday; Federal Reserve Chair Janet Yellen gives a speech and testimony on Thursday; and the November US Nonfarm Payrolls report will be released on Friday – traders would do well to heed warnings on the expected surge in volatility. The recent study by DailyFX Quantitative Strategist David Rodriguez showed how markets are pricing in the most volatile environment for EUR/USD not only in 2015, but perhaps over the last ten years overall! Given this expected volatility, traders operating in EUR-crosses over the coming week might find it beneficial to use "market range" orders when placing a trade to determine a comfortable range of prices where the order can execute.
Our concerns about a potential upheaval around the ECB this week are further supported by recent extremes in positioning among speculators in the futures market. As of the week of November 17, there was a build up to 164.2K net-short contracts from 142.9K net-short contracts for the week ended November 10. In context of prices, right after EUR/USD fell into its yearly low around $1.0460, speculators held 226.6K net-short contracts. It’s getting crowded in the short Euro trade, which means if the ECB disappoints, EUR/USD could be ripe for a short covering rally before the Fed’s December 16 policy meeting. As I’ve written about recently, the Fed could be setting up the US Dollar for weakness even if it hikes rates; a full-fledged EUR/USD reversal (in the scope of hundreds of pips to the upside) could develop around these central bank meetings over the next two weeks.
Lastly, as we approach the holidays and thus less liquid markets through the end of the year, it's worth reviewing principles that help protect your capital. We call these principles the "Traits of Successful Traders." –CV
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USD/JPY Stuck in Continuation Pattern Ahead of Japan GDP, BoJ Meeting
Fundamental Forecast for Yen:Neutral
The long-term outlook for USD/JPY remains bullish as the Federal Reserve remains on course to remove the zero-interest rate policy (ZIRP), but the key developments coming out of Japan may produce a larger correction in the exchange rate should the Bank of Japan (BoJ) continue to endorse a wait-and-see approach at the November 19 interest rate decision.
Despite forecasts for a widening trade deficit in Japan, the region’s 3Q Gross Domestic Product (GDP) report may encourage the BoJ to carry its current policy into 2016 amid expectations for an upward revision in the growth rate. As a result, signs of a stronger recovery may prompt BoJ to keep its asset-purchase program JPY 80T, and Governor Haruhiko Kuroda may continue to highlight an upbeat outlook for the world’s third-largest economy as the central bank head remains confident in achieve the 2% inflation goal over the policy horizon.
Nevertheless, the major data prints coming out of the U.S. may fuel expectations for a December Fed rate-hike as the Consumer Price Index (CPI) is expected to show a rebound in the headline reading for inflation, while the core rate is anticipated to expand an annualized 1.9% for the second-consecutive month in October. Sticky price growth may generate a growing dissent within the Federal Open Market Committee (FOMC) as Chair Janet Yellen sees the central bank on course to meet its dual mandate for full-employment and price-stability, but an unexpected slowdown in consumer price growth may undermine bets for a 2015 liftoff amid the ongoing 9-1 split within the central bank.
In turn, the fundamental developments coming out US/Japan are likely to spark increased volatility in USD/JPY as market participants gauge the next move by the Fed/BoJ, but the pair may consolidate ahead of the major event risk as it appears to be stuck within a bull-flag formation. Nevertheless, the deviating paths for monetary policy accompanied by the continuation pattern in price continues to highlight a long-term bullish outlook for the dollar-yen especially as the pair breaks out of the range carried over from back in September.
GBP/USD Rebound to Succumb to Dovish BoE Testimony, Strong US GDP
Fundamental Forecast for British Pound:Bearish
GBP/USD extended the rebound from earlier this month as the Federal Open Market Committee (FOMC) Minutes warned of a potential three-way split within the central bank, but the pound-dollar may struggle to hold its ground in the week ahead should the Bank of England (BoE) show a greater willingness to further delay its normalization cycle.
With the BoE scheduled to testify on its quarterly inflation report next week, the fresh batch of central bank rhetoric may dampen the appeal of the sterling should Governor Mark Carney highlight a more neutral outlook for monetary policy. Even though the preliminary U.K. Gross Domestic Product (GDP) report is expected to show the economy growing an annualized 2.3%, the disinflationary environment may continue to generate an 8 to 1 split within the Monetary Policy Committee (MPC) as the central bank anticipates price growth to hold below 1% until Spring 2016. In turn, the BoE may make further attempts to buy more time as the majority remains in no rush to lift the benchmark interest rate off of the record-low.
In contrast, an upward revision in the U.S. GDP print may fuel expectations for a December FOMC rate-hike as the central bank remains upbeat on the economy, and signs of a stronger recovery may boost the appeal of the greenback as market participants anticipate the core Personal Consumption Expenditure (PCE), the Fed’s preferred gauge for inflation, to uptick to an annualized 1.4% from 1.3% in September. Sticky price growth accompanied by a 2.1% expansion in the growth rate may keep the Fed on course to remove the zero-interest rate policy (ZIRP) in 2015 as the U.S. economy approaches full-employment, while Chair Janet Yellen remains confident in achieving the 2% inflation target over the policy horizon.
As a result, the long-term outlook for GBP/USD remains tilted to the downside as the Fed is widely expected to shift gears ahead of its U.K. counterpart, and the pair may largely fail to retain the rebound from the monthly low (1.5026) as market participants push out bets for a BoE rate-hike. Moreover, the advance from the April low (1.4565) may continue to unravel over the coming weeks as Fed Funds Futures show a 68% probability for a rate-hike at the December 16 interest rate decision.
How Much Air is Left in Gold Prices?
Fundamental Forecast for Gold: Neutral
The past six weeks have been brutal for Gold, and this was really sparked by rate hike expectations out of the Federal Reserve, as the top in Gold meshes well with the bottom in the US Dollar (both taking place on October 15th). But over the past six weeks, Gold is down by 11% and the dollar is only up by 8%; so this isn’t’ the only factor bringing pain to Gold prices. Numerous technical levels have given way, and Gold prices are sitting at six-year lows with very little support anywhere nearby.
Next week’s economic docket is absolutely loaded, and with Central Banks taking center stage beginning on Thursday with the December ECB meeting (even though RBA reports on Tuesday, nothing there is expected), followed by the Federal Reserve just two weeks later in the much anticipated meeting in which markets are expecting that first rate hike in nine years, Gold prices are likely to see continued volatility. Next week, following that ECB meeting on Thursday, we hear from Ms. Yellen as she appears before Congress. Any news or indications that further firm up those December rate hike expectations could lead to additional pressure in Gold prices. Expect that inverse relationship with the US Dollar to continue as traders bid up USD-assets ahead of the Fed.
From a technical standpoint: We’re trading at lows. There isn’t really much that you can do here unless price action moves back up to a resistance (or prior support) level with which you can base a short-side entry with an adequate stop. We discussed some of these potential levels in our most recent Technical piece on Gold. Outside of that, traders would need to utilize breakout-logic, and with prices having been chopping around at new five-plus year lows for the past 10 days, the risk of a reversal continues to increase as time passes without a retracement. As this market gets even more net short, we’re running out of new sellers to continue pushing prices lower. This is the danger of sentiment, and this is why you should take this into consideration when analyzing markets (you can follow sentiment of FXCM traders in Gold with our Speculative Sentiment Index Indicator). Because even if every factor in the world says prices should fall, if there is nobody left to sell, well prices are going to go up from simple deduction. Buyers will rule the day, even if there are only three or four of them, because there is nobody left to sell at those low prices.
BoC Governor Poloz Says Data Makes Rate Hike Miles Away
Fundamental Forecast for CAD: Bearish
Canada’s Dollar Remains Bidless Despite Other Commodity Reliant Currencies Catching a Bid on Suspect USD Strength
Canada Sept. Retail Sales Fell 0.5%, Est. 0.1% Causes BoC Governor Poloz To Say Data Makes Rate Hike “Miles Away.”
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.
In an ideal economy, which doesn’t exist anywhere, weakness in one sector would be followed or balanced by strength in another sector. For the Canadian economy, the hope would be that weakness in the energy market would be offset by the strength of Canadian households to spur demand thanks in part to the money saved by lower energy prices. However, that’s not happening, and it’s causing frustration at the Bank of Canada. It turns out that the oil-dependent Canadian economy isn’t having the resilience that the Bank of Canada would like to see, and that was shown via Retail sales this morning Dollar has continued to see weakness as the price of Oil sitting near $40 has put the country in a tough fiscal position. Specifically, the finance department showed Canada is on pace to end the year in the red to the tune of C$3 Billion as the economy has failed to revive itself due to the Oil Slump.
Earlier this week, we saw a dismal print in Canada Manufacturing Sales on Monday at -1.5% vs. 0.2%. This argues that the weakness in the economy is yet to be fully realized and that the shift to Non-Resource industries will be rough (a la Australia). Other domestic data last week was the Bank Canada Consumer Price Index Core (YoY) that slightly beat expectations at 2.1% vs. 2.0% exp. Next week, we will turn focus again to the direction of WTI Crude Oil to see if a breakout could potentially spur buying of the Canadian dollar as a value play. Outside of the reliance of Oil, the more important news event on Friday will be Industrial Produce Price MoM that expected to improve to -0.1% vs. prior readings of -0.3%. However, if Oil further pushes toward the August 24th low and Industrial Produce Price misses expectations, we could see CAD make another run at YTD lows.
On the charts this week, the Canadian Dollar failed to find the buyers that found other commodity currencies like the Australian and New Zealand Dollar. Even the Oil reliant Norwegian Krone ended the week up 0.5% to the USD. If Oil can catch a bid next week, we could see CAD play a game of catch-up in which the Canadian Dollar strengthens fast against the USD/CAD in a game of Fear of Missing Out (FOMO). After failing multiple attempts to break and hold above 1.3355 resistance, USD/CAD could test 1.3220 support. US Dollar trading will likely be thin next week due to the American holiday week so Oil will likely be the key driving of CAD until the economic calendar’s come back to life.
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Australian Dollar Faces Perfect Storm of Key Event Risk Ahead
Fundamental Forecast for the Australian Dollar: Neutral
RBA Rate Decision, 3Q GDP Data Unlikely to Disrupt Existing Policy Bets
ECB Meeting, Yellen Testimony and US Jobs Data Cloud Risk Trends View
Identify Critical Turning Points for the Australian Dollar with DailyFX SSI
The Australian Dollar faces a perfect storm of volatility in the week ahead as high-profile event risk on the homegrown and the external fronts looms ahead. Monetary policy considerations are first to take center stage, only to be replaced by churn in risk sentiment trends.
The RBA is expected to keep the benchmark lending rate unchanged at 2 percent at Tuesday’s meeting. This will put the focus on the accompanying policy statement and any forward guidance therein. A recent center-bound shift in the bank’s rhetoric degraded but has yet to destroy rate cut speculation.
Prevailing economic conditions are unlikely to have changed enough to trigger Governor Glenn Stevens and company to make a firm move out of wait-and-see mode. This points to a neutral policy statement echoing the data dependence of future actions, shifting the spotlight to the third-quarter GDP report due later in the week.
Output is seen rising 0.7 percent, an acceleration from the 0.2 percent gain in the three months through June. The year-on-year growth rate is seen edging up to 2.3 percent, marking recovery from the two-year low of 2 percent but still falling short of the long-term average in the 3-4 percent range. Absent a large upside surprise, the reading is unlikely to materially alter prevailing policy bets, at least for now.
Turning to external catalysts, the ECB is first to take center stage. President Mario Draghi is expected to unveil an expansion of policy support. A range of options ranging from expanding QE asset purchases to pushing the deposit rate deeper into negative territory has been hotly debated in recent weeks and investors will be keen to learn if officials decided to opt to a soft touch or a big-splash gesture.
On balance, the markets have been well-primed for some degree of easing, so the bar for a dovish surprise will be relatively high. That means the risk of a disappointment is probably disproportionately greater relative to the alternative. In that event, disappointed deterioration in sentiment trends may pressure the Aussie lower along with other risk-geared assets.
Finally, testimony from Fed Chair Janet Yellen and November’s US jobs report will guide the perceived probability of an FOMC rate hike in December. The chance of liftoff is already placed at 77.5 percent, making it relatively difficult to engineer a hawkish surprise, but sentiment’s inconsistent response to the building likelihood of stimulus withdrawal since mid-year makes for a clouded landscape. Knee-jerk volatility seems almost certain but its directional predilections are difficult to decipher.
Kiwi Catches its Footing Despite Another Spill in Milk Prices
Fundamental Forecast for the Kiwi: Bearish
In previous pieces on the New Zealand Dollar, we’ve discussed the correlation between Milk prices and the spot rate on the Kiwi-Dollar. This is kind of like a ‘soft commodity’ correlation, similar to how we’ll often see similar types of moves in metals and the Australian Dollar, or Oil and the Canadian Dollar. For economies that have considerable exposure to these commodity classes, it only makes sense that they price roughly in-line with the source commodity. Should prices go up, that means producers make more. With this additional profit, they can reinvest in their business; they can hire more people and that leads to lower unemployment. Wages then need to rise to attract workers to offset this competitiveness in the economy, and then we have inflation. At this point, Central Bankers will usually look at hiking rates (think of that!), and this could drive trade and capital flows into the market to get this new, higher rate. This is that beautifully synergistic impact of a growth story within an economy.
Well, that’s the opposite of what’s going on in New Zealand and, in turn, the rest of the world right now. Milk prices have been on a steady trajectory lower along with many other commodities, and as we had discussed last month, this has driven the New Zealand Dollar lower. For four consecutive dairy auctions starting in mid-August (auctions take place every two weeks), milk prices were on the rise. This increase lasted all the way to the October 20th auction, and this saw prices in the Kiwi-Dollar rise from a base of price action support at the .6250 area in early September, all the way up to just shy of the .6900-handle. But that October 20th auction showed a decline of -3.1% in dairy prices, and the Kiwi hastened its descent lower. From .6800, to .6700, to .6600 and finally knocking in support at the .6500-handle; and that’s how we started this week, having just caught support at a new major psychological support level.
But the Dairy auction on this Tuesday wasn’t very encouraging as prices spilled (pun intended) by -7.9%, sending the Kiwi even lower to find new support at .6425. A move higher towards the end of the week looks to be more positioning based, as the US Dollar put in considerable weakness on Thursday and this reflects in the NZD/USD spot.
With a holiday-shortened week in the US coming up, and with no major Kiwi data and no dairy auctions until we get into that first week of December that is just absolutely loaded with data, we may be nearing an attractive entry point for a short-side resumption play. Traders can look to base stops at .6650 to get risk levels above recent highs, with targets set towards those previous lows of .6200. With so little news on the docket, the week after next looks significantly more attractive for trend-continuation plays, but the ranges produced ahead of the data could offer adequate entry opportunities with an eye on the following week.
The forecast on the Kiwi-Dollar remains bearish.