daily fundamentals

US Dollar, Japanese Yen Dominate as Markets are Reminded of Importance of Risk Aversion

•    Euro, Swiss Franc Virtually Unchanged Despite SNB Intervention
•    British Pound Outlook Hinges Upon BOE Meeting Outcome and Status of Quantitative Easing
•    Australian Dollar Down with Other Carry Trades - Will the RBA Actually Raise Rates Again Next Week?

US Dollar, Japanese Yen Dominate as Markets are Reminded of Importance of Risk Aversion
The US dollar and Japanese yen were the strongest of the majors on a day when US stock indices plunged over 2.5 percent, indicating that market correlations and risk aversion are alive and well. In fact, the CBOE’s VIX volatility index, one of the prime “market fear” gauges, rose above 30 for the first time since July. FX carry trades took the biggest hit, as NZDJPY plummeted 3.74 percent while CADJPY and AUDJPY both lost just over 3 percent. Likewise, NZDUSD tumbled 2.2 percent while AUDUSD fell 1.8 percent, and the dour sentiment ran contrary to US economic news. Indeed, personal income and personal spending readings were right in line with expectations for the month of September, as incomes went unchanged while spending fell 0.5 percent, the sharpest drop since December 2008. A closer look at the report shows that wages and salaries contracted 0.2 percent during the month, and that weaker consumption came right after the end of the “Cash for Clunkers” program, highlighting the fact that growth in Q3 was due primarily to government stimulus efforts.

Meanwhile, the Purchasing Managers’ Index (PMI) for Chicago jumped to 54.2 in October from 46.1, thanks to increases in production and new orders. Indeed, the depreciation of the US dollar this year has helped improve foreign demand for US products, which has been quite beneficial for exporters. Finally, the University of Michigan’s consumer confidence index was revised to a final reading of 70.6 in October from 69.4, and this compares to a reading of 73.5 in September, which was the highest since January 2008. A breakdown shows that sentiment on current conditions remains at the highest levels in a year, while confidence in the outlook deteriorated.

Looking ahead to next week there will be a number of highly market-moving reports, including a rate decision by the Federal Reserve on Wednesday and the release of non-farm payrolls (NFPs) on Friday. First, though, the US dollar will face ISM manufacturing on Monday at 10:00 ET, which is projected to rise for the ninth straight month in October to 53.0, the highest level since August 2006, from 52.6. With 50 being the point of neutrality, this would also be the third month that the index signals an expansion in activity, adding to evidence that the sector is experiencing a recovery in business activity. The last release didn’t have much of an impact on the US dollar, as risk aversion dominated the day, leading the currency higher. However, the report will still be useful because of its employment component as a leading indicator for Friday’s US non-farm payrolls report.

Related Article: US Dollar to Remain Volatile Ahead of Four Major Rate Decisions and NFPs
 
Euro, Swiss Franc Virtually Unchanged Despite SNB Intervention
The euro and Swiss franc were mixed against the majors, as they fell against the low-yielding US dollar, euro, and British pound but rose versus the commodity dollars. European data was right in line with expectations, as the annual rate of Euro-zone CPI growth remained negative for the fifth straight month in October at -0.1 percent, from -0.3 percent. Indeed, the appreciation of the euro against currencies like the US dollar and British pound has served to keep a lid on inflation pressures, which were already depressed from weaker commodity costs. The bigger news of the day, though, was the choppy price action seen in EURCHF, as the pair rocketed higher around 7:30 ET, looking very much like an intervention attempt by the Swiss National Bank (SNB). As usual, the SNB did not comment on the moves, but they have said in the past that they would actively try to prevent a further appreciation of the Swiss franc against the euro, so the shift is not entirely surprising. Nevertheless, market forces won out and EURCHF ended the day virtually unchanged.

British Pound Outlook Hinges Upon BOE Meeting Outcome and Status of Quantitative Easing
The British pound was mostly stronger against the majors, though the currency’s more notable move was in its decline against the US dollar and Japanese yen. The British pound is likely to remain very volatile next week ahead of the Bank of England’s (BOE) rate decision on Thursday at 7:00 ET. The BOE is anticipated to leave rates unchanged at 0.50 percent, but this won’t even be the market-moving part of the announcement. Instead, traders will be looking toward the BOE’s policy statement. This has consistently been the prime “news event” of recent rate decisions. Last month, the BOE indicated a neutral stance as they stated they would continue their £175 billion quantitative easing (QE) program, and this ultimately led the British pound to rally against the US dollar and euro immediately. This time around, though, a Bloomberg News poll is calling for the Monetary Policy Committee (MPC) to expand their QE program by £50 billion to £225 billion following the Q3 reading of UK GDP, which showed that the economy remains in recession, and such a reading would have dire consequences for the currency. However, if the BOE allows the program to expire, the British pound is likely to gain.

Australian Dollar Down with Other Carry Trades - Will the RBA Actually Raise Rates Again Next Week?
The Australian dollar was crushed by lower-yielding currencies on Friday, as market sentiment favored “safe haven” assets. The Australian dollar will face significant event risk on Monday night as the Reserve Bank of Australia (RBA) will announce their latest rate decision, and according to Bloomberg News and Credit Suisse overnight index swaps (OIS), they will raise rates for the second straight month by 25 basis points to 3.50 percent. Looking even further ahead, OIS rates are pricing in 192 basis points worth of hikes over the next 12 months. However, as recently as October 20 - the day before AUDUSD hit its 2009 high of 0.9326 - OIS rates were pricing in 216 basis points worth of increases, but have since gradually faded as speculation that the global economy is in the midst of a broad-based recovery have given way to concerns that signs of growth are just temporary. As a result, the RBA’s rate decision and policy statement could prove critical to the AUDUSD outlook in the near-term.

While the RBA did leave the door open to further rate increases in their last statement by saying that “it is now prudent to begin gradually lessening the stimulus provided by monetary policy,” the downward pressures on inflation formed by the sharp appreciation of the Australian dollar may prevent the central bank from tightening policy again right away. If this is the case and the RBA leaves rates unchanged at 3.25 percent, the Australian dollar is likely to plunge on the news. On the other hand, a rate increase in line with forecasts could keep the currency within its uptrend.

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**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

Written by: Terri Belkas, Currency Strategist for DailyFX.com
E-mail: tbelkas@dailyfx.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.
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