Dollar Bull Run Longest on Record after Fed Updates Rate Outlook
Fundamental Forecast for Gold:Bearish
As lackluster as the volatility and sentiment reaction was to last week’s FOMC decision, the event sustained the Dollar’s incredible run. Now on a 10-week bullish binge, this is the most enduring greenback run on record. Some will immediately consider this a ‘mature’ and ‘overbought’ market by virtue of its pace alone. Fundamentals, however, are not ready to revoke support for the bulls. As has been the case over the past weeks, key for the Dollar moving forward is the level of appetite for liquidity and the outlook for US interest rate expectations. And considering the scenarios, it may prove difficult to capsize the currency.
In the primary fundamental veins that feed the dollar, interest rate expectations have offered the greatest blood flow to the bulls’ cause. While the Federal Reserve’s communication effort at this past week’s monetary policy meeting left much to be desired, there was enough tangible evidence of the march towards a first rate hike to rouse the bulls. While the second-to-last Taper (QE3 is expected to end at the next meeting on October 28 according to Chairwoman Janet Yellen) was a concrete step, it was the forecasts that really caught traders eyes. The outlook for employment, inflation and growth were little changed; but the interest rate projections increased substantially.
In its consensus, the FOMC shows 14 of 17 members believe it is appropriate to start raising rates in 2015, versus 12 at the previous review. Furthermore, through the end of 2015, the Fed now expectes its Fed Funds rate to be at 1.38 percent. At the close of 2016, the benchmark is seen at 2.88 percent. That compares to forecasts of 1.13 and 2.50 respectively offered up in June – a full 25bp hike higher. That hawkishness is a boon to the Dollar as it sets it on a faster course to climbing the carry trade scale before most of its counterparts. In fact, this ‘dividend’ forecast keeps the Fed on pace to potentially realize its first hike before all the majors with the exception of the BoE, and its subsequent pace is arguably more intense than all counterparts.
If there is a full consensus on the hawkish outlook, and investors have already positioned for such a future; then there could be a moderation of its subsequent climb without fresh updates to reinforce the theme or a new fundamental driver to take over. However, this well has not been fully tapped. While the currency and Treasury yields have climbed through the past months, there is still a dramatic disparity between the what the Fed is projecting and what the markets are accounting for. We can see that most directly in Fed Fund futures (a product used to hedge interst rate changes) which are pricing in a 0.78 percent rate by the close of next year (a 60bp discount to the FOMC forecast) and 1.38 percent by December of 2016 (a 150 bp difference).
There is significant risk from the central bank’s perspective for the markets to be so far off the guidance they are trying offer. Last minute adjustments by the financial market to policy changes are typically much more violent. Yet, the central bank has contributed heavily to this confusion with mixed signals in its communications. Chairwoman Yellen made a considerable effort to avoid questions in her press conference about the signs that the market’s view didn’t match the Fed’s own rate outlook. We will see if FOMC members will try to rectify this in the week ahead. There are 10 scheduled speeches from 8 Fed members. The balance of their views – with special note of 3 ‘neutral’ 2016 voters (Powell, Dudley and Lockhart) – should be watched closely.
One reason why obfuscation may actually be a strategy from the Fed is that the shift to a tightening policy could upset the fragile balance of complacency that has drove asset prices to record highs, on decades low participation rates and record leverage. The growth in accommodation made by the ECB, BoJ and PBoC may work to offset the withdrawal; but a misstep can be disastrous. A meaningful correction is inevitable over a long-enough time frame. And we are three-years without a 10 percent S&P 500 pullback. Central banks may not be able to keep the peace. And if they fail, risk aversion could give the dollar an even bigger boost…
Euro at Potentially Significant Turning Point
Euro at Potentially Significant Turning Point
Fundamental Forecast for Euro: Neutral
The Euro tumbled to fresh lows versus the high-flying US Dollar on a week of bad news for Europe and much better developments out of the US. But why might the Euro/Dollar exchange rate be at risk of an important bounce?
Almost all traditional fundamental signals point to further Euro weakness, and yet we see clear warning signs that such news and sentiment may be overdone. Everyone is bearish at major market bottoms and bullish at the tops, and that in itself is an important trigger which favors some sort of Euro bounce. Beyond that, however, we see technical reasons why the US Dollar rally may be overdone.
High FX market volatility continued to drive the safe-haven US currency higher across the board as the combination of a US Federal Reserve Meeting, key European Central Bank results, and the highly-anticipated Scotland independence referendum fueled major moves. Yet the week ahead promises far less foreseeable event risk, and our forward-looking DailyFX 1-Week Volatility Index has pulled back sharply. The US Dollar’s strong correlation to volatility leaves it at risk on such a slowdown.
It’s possible but unlikely that the Euro sees strong reactions to upcoming European Purchasing Managers Index (PMI) survey results, a German IFO Business Climate report, and a late-week GfK Consumer Confidence data release. Thus we’ll focus on how US Dollar traders react to calmer markets; we suspect that the EURUSD could bounce as sellers lose enthusiasm.
Recent FXCM Execution Desk numbers show that total Euro trading volume slowed even as it tumbled to fresh lows. While momentum clearly favors further losses, the slowdown acts as clear warning that markets may soon capitulate.
And thus we’re left with somewhat of a dilemma: on the one hand we believe that the Euro will remain in a downtrend, but too many signs warn of a near-term price and sentiment extreme. We advise caution on fresh EURUSD-short positions in the days ahead.
--- 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.
Contact and follow David via Twitter: https://twitter.com/DRodriguezFX
Japanese Yen May Rebound as Risk Aversion Sweeps Financial Markets
Fundamental Forecast for Japanese Yen: Bullish
ECB, PBOC Easing May Not Sustain Sentiment Trends Absent the Fed
Risk Aversion to Fuel Carry Trade Unwind, Boosting the Japanese Yen
Help Identify Critical Turning Points for USD/JPY Using DailyFX SSI
The markets navigated through a treacherous succession of high-profile event risk over the past two weeks, leaving investors with much to digest. Investors will have just such an opportunity in the week ahead as a lull in news-flow allows for a period of reflection. This process may pave the way for a recovery in the Japanese Yen after the currency slumped to a six-year low against the US Dollar.
The fragility of market-wide risk appetite is the key consideration. September began with an underwhelming easing effort from the European Central Bank (ECB). The markets were holding out for the launch “classic” QE – the purchase of government bonds with printed money – and didn’t get it. Confidence in another key component of the ECB’s stimulus package was shaken last week as the first TLTRO operation saw uptake of just €82 billion, far less than the expected €150 billion result.
In the meantime, the Federal Reserve seemed to move closer to the hawkish side of the policy spectrum. An updated set of policymakers’ interest rate projections suggested Janet Yellen and company now expect borrowing costs to be a full 25bps higher in 2015 than they thought in June. The markets have taken notice: traders are now pricing in 60bps in US policy tightening over the coming 12 months, the most in the G10 FX space.
This seems to bode ill for sentiment, which has managed to remain as resilient as it has been largely on the back of generous Fed accommodation over recent years. With the US central bank ever-closer to withdrawing its support and the ECB effort to replace it looking increasingly inadequate as a replacement, the threat of on-coming risk aversion appears to be growing.
China presents one mitigating factor. Risk appetite swelled after the PBOC unveiled a new SLF facility injecting CNY500bn into its banking sector considering the move amounted to the approximate equivalent of a 50bps RRR decrease. Optimism may prove fleeting however considering the liquidity provision has a defined 3-month shelf life however, whereas an outright RRR rate cut would amount to an open-ended loosening of policy. That means investors may not find lasting comfort in Beijing’s efforts.
Given the time to consider such macro-level forces, the markets may well conclude that the sum total of support offered by central banks outside of the US will not be able to replace the Fed at a foundation for sentiment trends. This points to a forthcoming selloff across the range of risky assets, opening the door for an unwinding of Yen-funded carry trades that sends the Japanese unit swiftly higher.
GBP/USD Risks Larger Rebound on Fed Doves; Higher-Lows in Focus
Fundamental Forecast for Pound:Bullish
The GBP/USD fell back from a fresh weekly high of 1.6523 even as Scotland voted to stay within the U.K., but fresh commentary coming out of the Federal Reserve may spur a further advance in the exchange rate should the group of central bank doves talk down interest rate expectations.
A further expansion in U.K. home loans may encourage an improved outlook for growth, but market participants may ultimately turn a blind eye to the minor data prints coming out of the U.K. as the Federal Open Market Committee (FOMC) is widely expected to halt its quantitative easing (QE) program at the October 29 meeting. The key speeches by Fed voting-members William Dudley, Narayana Kocherlakota Jerome Powell and Loretta Mester may play a greater role in driving the GBP/USD next week amid growing speculation of seeing a rate hike sooner rather than later.
Indeed, a greater emphasis to retain the zero-interest rate policy (ZIRP) for an extended period of time may undermine the bullish sentiment surrounding the greenback as Credit Suisse Overnight Index Swaps show a jump in interest rate expectations, with bets of seeing at least 50bp worth of rate hikes in the next 12-months. As a result, a wave of dovish remarks from Fed officials may generate a more meaningful rebound in the GBP/USD as the Bank of England (BoE) sticks to its current course for normalizing monetary policy.
Despite the failure to hold above the 1.6500 handle, the recent series of higher-lows in the GBP/USD certainly paints a constructive outlook for the British Pound, and we may see the pound-dollar break out of the downward trending channel carried over from back in July should the group of Fed officials remain reluctant to move away from the highly accommodative policy stance. - DS
Fed Sends Gold Sharply Lower- Death Cross Warns of Further Losses
Fundamental Forecast for Gold:Bearish
Gold prices are softer this week with the precious metal off by 1.13% to trade at $1215 ahead of the New York close on Friday. The decline marks the third consecutive weekly loss for bullion with persistent strength in the greenback keeping pressure on commodities based in US dollars. The losses were especially severe in the precious metals with platinum down 2.47%, palladium down 3.12% and silver down more than 4% on the week.
The FOMC’s September rate decision was central focus this week and fueled a surge in volatility as the Central Bank retained its pledge to keep its highly accommodative stance for an extended period of time. Even though the Fed’s updated forecasts showed a narrowing corridor from the June projection, interest rate expectations jumped as Richard Fisher joined Charles Plosser to vote against the dovish tone surrounding the forward-guidance for monetary policy. With that said, the final 2Q GDP report is expected to show another upward revision to reflect an annualized 4.6% rate of growth, and the data may further boost interest rate expectations as the growing rift within the committee suggests that the central bank may be preparing to shift gears at the October 29.
From a technical standpoint, gold broke below support at $1229 this week and our broader outlook remains weighted to the downside while below $1243. Note that a death cross has been identified with the 50-day moving average breaking below the 100 for the first time since late May. In that instance gold saw a near 4% decline before recovering in early June. Look for key support at $1203/06, a region defined by the December 31st close (day the yearly low was made) and the 88.6% retracement of the advance into this year’s high. A break below this level keeps our bias in play eyeing subsequent support targets at the 100% Fibonacci extension off the 2014 high at $1193 & the 2014 low at $1178. -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.