Dollar and Market Confidence Ride on FOMC Decision
Fundamental Forecast for Dollar:Bullish
In a deluge of event risk this week, the FOMC rate decision stands as a focal point for the Dollar and market sentiment
A status quo or slightly hawkish lean from the Fed risks reviving the fallout of the ‘Taper Tantrum’
See the fundamental and technical forecast for the USDollar in our updated 4Q Forecast Trading Guide
The US Dollar managed to muscle out a modest advance this past week despite favorable winds for investor sentiment (through benchmarks like S&P 500 and volatility indexes) as well as a persistent dovishness in rate forecasts. Such resilience given the downgrade in its return potential and disinterest in safe havens is encouraging. However, that shouldn’t lead us to view the currency as being fundamentally indestructible. Last week was a period of respite. Reflection after the broad selling of ‘risk’ through the opening half of October is reasonable when key, open-ended fundamental themes are unresolved…and facing the kind of definitive milestones we expect in the week ahead. Both the Greenback and market-wide sentiment may finally find their cue for trend in the forthcoming event risk.
From a wealth of US and global event risk scheduled through the coming week, the most potent catalyst will be the Federal Open Market Committee’s policy decision Wednesday (18:00 GMT). This will be important for the Dollar on multiple levels. It will most readily feed speculation surrounding the relative future yield of the US currency and its assets. In the past few weeks, US rate forecasts have collapsed. A combination of downgraded global growth forecasts, tepid domestic data and provocative comments from a few Fed officials has pushed out expectations for the first rate hike and the trajectory of the pace thereafter.
From Fed Funds and Eurodollar futures (used to hedge interest rate risk), we find the market doesn’t entertain the chance of the first hike in the policy regime change until September 2015. Previously, the running consensus was for a ‘mid-2015’ move interpreted as the June 17 meeting. Furthermore, the pace of tightening has been downgraded so that now the benchmark rate is expected to be 0.46 percent on December 2015 and 1.36 percent come December 2016. The FOMC’s own consensus forecast for the same periods released just last month are 1.13 and 2.50 percent respectively. That is a substantial discount the market is ‘pricing in’.
This severe discrepancy will shape the market’s reaction to the event itself. Given the dovish view, a ‘neutral’ outcome could elicit a strong bullish outcome for the Dollar. In this case, holding true to the central bank’s trend through its past meetings of a final Taper to the QE3 program and undisturbed consensus (cautious optimism for the economy and employment) would indicate to the market that the Fed is keeping to its schedule and the consensus forecasts they produced in September. To meet the market’s level of dovishness, we would need to see either a delay in the final Taper (highly unlikely) or a significant softening to the tone in the monetary policy statement that accompanies the announcement.
What makes the upcoming rate decision even more intoxicating for the Dollar is its potential systemic influence over sentiment. Many attribute the sharp drop in global equities and other return-oriented markets earlier this month to a ‘Taper Tantrum’ – or the realization that stimulus regimes were shifting and the support for excessive risk taking was reversing. If that fundamental assessment is accurate, the Fed maintaining its path towards tightening can quickly wipe out this past week’s gains and definitively undermine a precarious market structure of record leverage, tepid participation and dependency on extremely low volatility conditions. In other words, we could see an aversion to risk that can fully engage the greenback’s safe haven quality.
While much of the Dollar’s and market’s potential revolves around the FOMC decision, there will be plenty of event risk at hand. The US 3Q GDP reading and the impact to the Euro (the second most liquid currency) from a glut of important event risk should also be monitored. Yet, should push come to shove, an active response to the FOMC will override all other interests. – JK
Short-term Euro Rebound Due as Data Improves, Stress Tests Pass
Fundamental Forecast for Euro: Neutral
- The Euro’s performance has been broadly mixed the past month, but there are selective opportunities both long and short.
- EURUSD may be setting a higher low as the economic data drought ended with surprise German, EZ PMIs.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro continued its process of stabilization for the third consecutive week, although a slightly more negative tone was apparent in the run up to the release of the European Central Bank’s asset quality review (AQR, stress tests) The 18-member currency posted gains against only two of the major currencies covered by DailyFX Research, with EURUSD falling by -0.71% to $1.2671. A culmination of factors over the last few days and weeks may be gathering for Euro strength in the near-term
Aided by much better than expected preliminary October German and Euro-Zone PMI data, gauges tracking Euro-Zone economic momentum have turned sharply higher from their lowest levels of the year. While the yearly low was set on October 14 at -57.3, the Citi Economic Surprise Index shot up to -36.8 by the end of this past week. Relatively speaking, data has been less disappointing and even positive in select cases.
Following the small improvement in data momentum, medium-term inflation expectations rebounded slightly this week as well. The 5Y5Y breakeven inflation swap, the European Central Bank’s preferred market measure of medium-term inflation expectations, edged higher from 1.779% to 1.791% - not a terrific rebound, but still moving in the direction the ECB’s policy is hoping for. The yearly low was set on October 15 at 1.541%.
These improving economic data trends are now bolstered by what should be considered a better than expected round of stress test results. The AQR was released on Sunday at 12 CET, and showed that while 25 Euro-Zone banks failed the tests totaling €24.2B in capital shortfall, 12 banks have already raised enough capital to cover their respective shortfalls.
The total shortfall after the 12 banks raised capital fell to €9.5B – a much more manageable figure. Various banks’ estimates pegged the cumulative shortfall from anywhere to low tens of billions to as high as €100B.
If there was ever a chance for the Euro to take advantage of near-term conditions, the moment may be ripe for the elusive Euro short covering rally. The fuel here, of course, is the stretched futures market positioning. Non-commercials/specs held 159.4K net-short contracts for the week ended October 21, an increase from the 155.3K net-short contracts held a week earlier.
Outside of the very immediate time horizon, the outlook is still fairly bearish: sovereign QE is still widely expected from the ECB next year while other major central banks (BoE, Fed) winddown their expansive stimulus policies. –CV
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USD/JPY to Eye Fresh Highs on Less-Dovish FOMC, More BOJ Easing
Fundamental Forecast for Japanese Yen: Bullish
The fundamental outlook for USD/JPY remains bullish as Federal Open Market Committee (FOMC) moves away from its easing cycle, but the dollar-yen may struggle to press fresh highs next week should the Bank of Japan (BoJ) refrain from further expanding its asset-purchase program.
With the Fed’s QE exit largely priced-in, the forward guidance for monetary policy is likely to have a greatest impact on the USD/JPY, and we will favor a further appreciation in the greenback should the central bank show a greater willingness to remove the zero-interest rate policy (ZIRP) in 2015. On the other hand, the fresh batch of central bank rhetoric may drag on interest rate expectations as the majority remains in no rush to normalize policy, and we may see a larger correction in the reserve currency should the central bank look to retain its highly accommodative policy stance for an extended period of time.
In contrast, market participants are still looking for a further expansion in the BoJ’s asset-purchase program as lower energy costs curb the outlook for inflation, and the Japanese Yen may face additional headwinds over the near-term should Governor Haruhiko Kuroda take additional steps to stimulate the ailing economy. However, the BoJ may stick to its current policy as the central bank head remains confident in achieving the 2% target for price growth, and the Yen may outperform against its major counterparts should market participant pare bets of seeing additional monetary support in Japan.
With that said, the USD/JPY may extend the recent series of higher highs & lows on more easing from the BoJ along with a less-dovish statement from the Fed, but the pair may fail to retain the rebound from 105.18 should both central banks disappoint. - DS
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 Losses to Accelerate on Less Dovish FOMC- Support Break Eyes 1206
Fundamental Forecast for Gold:Bearish
Gold prices are softer this week with the precious metal off by 0.55% to trade at $1231 ahead of the New York close on Friday. The losses come amid a sharp rebound in broader equity markets with the S&P 500 marking its strongest weekly performance since early January 2013. Although newswires remain largely dominated by Ebola headlines, markets have largely shifted focus with all eyes on next week’s key US event risk.
Looking ahead to next week, the FOMC policy meeting will be central focus with the central bank widely expected to end its asset purchase program. With headline CPI data this week coming in stronger than expected, close attention will be given to the verbiage of the accompanying policy statement as investors look for clues as to the Fed’s outlook on interest rates. The advanced read on 3Q GDP is released the following day with consensus estimates calling for a print of 3% q/q, down from the robust 4.6% q/q seen in 2Q. A hawkish tone to the policy statement on the back of the improving US data flow is likely to put pressure on bullion prices with the technical picture suggesting that prices remain vulnerable heading into the end of the month.
From a technical standpoint, gold reversed off of a key resistance range defined by the June close lows, the 38.2% retracement of the July decline and the 61.8% extension of the advance from the October low at $1244/48. Although the rally reached as high as $1255, prices failed to close above and the focus remains on this key resistance range. A breach above $1248 eyes more significant resistance at $1260/63 and $1283 where ultimately we would start looking for favorable short entries. Support rests with the 38.2% retracement of the monthly advance at $1222 with subsequent support objectives eyed at $1206 and $1178/82. It’s worth noting that while this week’s price action shifts our near-term bias to the short-side, the initial monthly opening range did break to the topside and another run at the highs cannot be ruled out before the broader downtrend resumes. Look for the FOMC rate decision to offer a catalyst here as we head into the close of the month with our attention shifting to the November opening range.
---Written by Michael Boutros, Currency Strategist with DailyFX
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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 A Potential Breakout On US Heavy Event Risk
Fundamental Forecast for Australian Dollar: Neutral
AUD/USD Remains Range-Bound Despite Plenty Of Intraday Volatility
Void of Major Domestic Data To Leave Steadfast RBA Policy Bets Intact
Volatility Swell and US-Centric Event Risk To Offer AUD/USD Guidance
The Australian Dollar witnessed another week of wild intraday swings that seemingly found little follow-through. Traders looked past another status-quo set of RBA Meeting Minutes that reinforced the prospect of a “period of stability” for rates. Further, CPI figures remained contained within the central banks’ target range, doing little to alter steadfast policy expectations. Similarly, top-tier data from regional powerhouse, China, failed to deliver lasting cues for the currency.
A light domestic economic docket over the coming week is likely to leave RBA policy bets well-anchored and see the Aussie take its cues from elsewhere. While the AUD’s yield advantage has remained robust, its appeal has waned due to elevated volatility levels. This in turn is likely to cap carry trade demand for the currency even alongside broader improvements in risk sentiment.
The catalyst for the next break lower for AUD/USD is likely to emerge from the US Dollar side of the equation. The upcoming FOMC decision may offer the spark needed if the statement offers a more hawkish lean that focuses on labor market improvements, rather than subdued inflation.
Speculators remain net short the pair according to the latest COT figures. Yet positioning is roughly half what was witnessed in mid-2013, suggesting the short trade is far from being “crowded”.
Downside risks remain centered on the 2014 lows near 0.8660, which if broken on a ‘daily close’ basis could pave the way for a descent on 0.8320 - the July 2010 low.For more on the US Dollar side of the equation read the weekly forecast here.
Written by David de Ferranti, Currency Analyst, DailyFX
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New Zealand Dollar at Risk on Dovish RBNZ, Status-Quo FOMC
Fundamental Forecast for New Zealand Dollar: Bearish
NZ Dollar Vulnerable if RBNZ Opts to Augment Future Rate Hike Pledge
Status-Quo FOMC May Send Kiwi Lower as Fed Tightening Bets Rebuild
Help Identify Critical Turning Points for NZD/USD Using DailyFX SSI
The New Zealand Dollar is in for a volatile period in the week ahead as a hefty dose of domestic fundamental event risk is compounded by high-profile macro-level developments. On the home front, the spotlight is on the RBNZ monetary policy announcement. September’s outing marked a shift into wait-and-see mode after four consecutive rate increases. The central bank is widely expected to maintain the benchmark lending rate unchanged again, putting the policy statement under the microscope as traders attempt to infer where officials will steer next.
Last month, the RBNZ argued that while “it is prudent to undertake a period of monitoring and assessment before considering further policy adjustment…some further policy tightening will be necessary.” Since then, CPI inflation has plunged to the weakest in a year while the exchange rate – a perennial source of concern over recent months – arrested a three-month decline and began to recover. This may prompt the central bank to withdraw language signaling renewed rate hikes are on the horizon after the current “assessment period” runs its course, an outcome which stands to undercut yield-based support for the New Zealand Dollar and send prices lower.
Externally, the central concern preoccupying investors is the ability of a resurgent US economy to underpin global growth, offsetting weakness in China and the Eurozone. That puts the FOMC monetary policy announcement in the spotlight. Janet Yellen and company are widely expected to issue one final $15 billion reduction in monthly asset purchases to conclude the QE3 stimulus program. The probability of a surprise extension seems overwhelmingly unlikely. That means the announcement’s market-moving potential will be found in guidance for the timing of the first subsequent rate hike inferred from the accompanying policy statement.
Recent weeks have witnessed a moderation in the Fed tightening outlook as global slowdown fears encouraged speculation that the central bank will want to safe-guard the US recovery from knock-on effects of weakness elsewhere by delaying normalization. Indeed, fed funds futures now reveal priced-in expectations of a rate hike no sooner than December of next year, far later than prior bets calling for a move around mid-year. A change FOMC statement reflecting renewed concerns about persistently low inflation would validate this shift. Alternatively, a restatement of the status quo would hint the markets’ dovish lean has over-reached, triggering a readjustment and putting pressure on the Kiwi. Considering the Fed’s steady hand through the first-quarter US slowdown, the latter scenario seems more probable.