Dollar Faces Rate Speculation, Risk Trends, Central Bank Moves
Fundamental Forecast for Dollar:Neutral
The PCE inflation gauge and NFPs will shape rate speculation that still has market pricing October hike
Expected easing efforts by the ECB, RBA and BoC can leverage the Dollar’s outlook for rate hikes
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The Dollar received a jolt of volatility this past week in a rally that followed the CPI inflation report, but the currency was unable to escape the bounds of a month-long range. It will be increasingly difficult to maintain a range going forward however. Not only are major themes like US rate forecasts and risk trends developing, but we have a range of high profile event risk. While US indicators like the February NFPs will provide a clear connection to Dollar activity; policy decisions by some of the Fed’s largest counterparts – the ECB, BoE, RBA and BoC – can generate considerable indirect force.
For Dollar traders, the outlook is steeped in two key fundamental themes: monetary policy and speculative sentiment. It is the former that has fed the Greenback’s bullish trend these past nine months (the ICE Dollar Index secured an eighth consecutive rally – a record- while the Dow Jones FXCM Dollar Index closed the month slightly lower). Yet, just as clear as the ‘relative’ hawkish outlook for the Fed has generated such a resounding performance, we can also see its limitations shaped through the month-long consolidation pattern the benchmark established through February.
Compared to the ECB and BoJ (who are executing quantitative easing programs) or the RBA and BoC (which have recently cut their benchmark rates), the FOMC is exceptionally hawkish. Though it is still plotting the time frame for its first hike in a controlled normalization regime, a tightening move offers drastic contrast. Much of this has been priced in however. Currently, the market expects a first and second rate hike in 2015 – something the other majors cannot claim. To leverage further gains on this view though, the lead needs to be extended.
According to Fed Fund futures, the first move by the Fed is expected around the October 28 meeting. Alternatively, surveys for economists, analysts and primary dealers pegs it around June 17 or July 29. That opens the door for more progress. A few particular data points stand out over the coming week that can up the market’s expected time frame – or push it back depending on the outcome. At the start of the week, we have the PCE inflation measures. Given that this is the Fed’s preferred price gauge, a surprise here could generate a greater market response than the heft Dollar bid that followed last week’s CPI release. At the end of the week, the February labor data will be a media and speculative focus. While the payrolls and jobless figure are important, we know the general trend of the past five years. The missing puzzle piece for hikes is inflation. And that leverages the importance of the average hourly wages component which last month posted the biggest monthly jump since December 2008.
A change in tide and intensity of the US rate forecast is the most direct means to motivate the Dollar, but don’t write off the strengthening or weakening of its collective counterparts as a capable impetus. The ECB is set to activate its stimulus program while the RBA and BoC are expected to each supply a consecutive interest rate cut. There is plenty of room to broaden or close that gap.
There will be plenty on the docket – and no doubt newswires – to occupy our attention in the week ahead. Yet, it is important to maintain a firm grasp of the ‘big picture’. The view of US monetary policy compared to its conterparts is a node, but how collective monetary policy influences global investor sentiment is a central pillar. ‘Risk appetite’ has not contributed much to the Dollar’s cause – bullish or bearish – recently as it has not moved with conviction (regardless of what it seems the S&P 500 is doing). It is difficult to instill confidence of a robust extension of already mature risk accumulation trends. In contrast, the correct spark can ignite an explosive value gap to risk aversion and deleveraging. When this reallocation hits, the Dollar will gain at the extremes.
Greece Kicks the Can again, Euro Only Benefits if Focus Turns to Data
Fundamental Forecast for Euro: Neutral
- The retail crowd remains net-short EURUSD, but has taken the dips as an opportunity to reduce shorts.
- Technical breakdowns in EURJPY and EURUSD have been disrupted by Greek-related headlines.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
After a week filled with doubt and uncertainty, the Euro was able to look past tumultuous headlines surrounding the Greek-Eurogroup debt negotiations, and finish mostly unchanged against a basket of its major counterparts. On the extremes, EURAUD fell by -1.15% and EURCAD gained +0.55%, while in between EURGBP slipped by -0.14% and EURUSD edged lower by -0.11%. Needless to say, these price movements aren’t exactly the signs of the wheels falling off the Greek negotiations, or an existential crisis about the fate of the Euro entering the discussion.
Traders, having already embraced one of the most bearish views of the Euro on record – having entered the week with 194.6K net-short contracts on the books, just shy of the all-time high of 214.4K net-shorts set during the week ended June 5, 2012 – may have simply reached an exhaustion point for interpreting Greek-related headlines. With short positions having been marginally reduced for the week ended February 17 (down to 185.6K net-short contracts), traders may be best suited to take advice from one of the legends, George Soros: “The worse a situation becomes the less it takes to turn it around, the bigger the upside.”
Lingering concerns over how the Greek agreement with the Eurogroup plays out are holding the Euro back. The extension agreement kicks the can down the road for four months, eliminating an immediate insolvency concern, but does little to address the ongoing liquidity crisis faced by Greek banks. Estimates suggest that some €10-20bn have been withdrawn from Greek banks over the past three-months, leaving the Greek banking system wholly-reliant on the European Central Bank’s emergency lending assistance (ELA) facility. For now, with the possibility that the ECB restricts ELA access (like it did to Cypriot banks in 2013), traders may be keeping their bearish Euro positions on the table with an eye towards capital controls and bank holidays hitting Greece over the coming weeks.
If only markets were able to shift their attention away from Greece, might the Euro be able to benefit. As we saw in the first set of ECB minutes released on Friday, the debate within was not only about the timing of a QE program (non-news; we know it begins in March) but also about what conditions could necessitate the end of the German-despised, expansionary program. This is a conversation worth paying attention to, especially now that incoming data from the Euro-Zone is improving at a solid pace.
The Citi Economic Surprise Index for the Euro-Zone hit +56.1 at the end of the past week, its highest level since March 7, 2013 (+56.5), while blowing out to its widest spread against its US equivalent since September 2010. In other words, relative to expectations, Euro-Zone data has been outpacing US data at its best clip in nearly four and a half years. Accompanying the improved data have been measures of rate expectations backing off all-time extremes, too. Morgan Stanley’s ‘months to first rate hike’ index (MSM1KEEU) resides at 45.6 (suggesting a December 2018 rate hike), down from levels seen over the past few weeks suggesting that rates would remain unchanged until March 2019.
The Euro-Zone is still a bonafide mess, politically and economically, but the data has undoubtedly been more positive in recent weeks. Inflation expecations have steadied too: the 5-year, 5-year inflation swaps (FWISEU55) ended the week at 1.603%, just above the four-week/20-day average of 1.586%. But for lingering concerns over Greece, the current 185.6K net-short contracts among speculators looks overdone – providing a viable source of tinder for a short covering rally. –CV
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US Dollar Likely to Reverse versus Japanese Yen in Week Ahead
Fundamental Forecast for Japanese Yen: Neutral
The Japanese Yen traded lower versus the US Dollar for the third week in four and left the USDJPY exchange rate near the key ¥120 level. Why might the week ahead finally bring a major breakout?
Traders have shown little interest in pushing the Yen beyond its narrow three-month trading range, but any significant surprises in upcoming US Personal Income/Spending and Nonfarm Payrolls labor data could change outlook for the otherwise-rangebound USD/JPY exchange rate. A fairly consistent rally from January lows near ¥116 suggests that the next major USDJPY move will be to the topside. Relatively low trader volumes in recent weeks nonetheless limits our enthusiasm for fresh USDJPY-long positions, however. We would ideally see a major shift in market conditions and trader attitudes to justify calling for a sustained break higher.
The key question remains unchanged: when will the US Federal Reserve begin raising interest rates? Yield-seeking investors have typically sold the Japanese Yen against higher-yielding currencies through normal rate environments. And indeed, the fact that the US Fed appears to be the only major central bank to act in 2015 has helped push the US Dollar to 8-year peaks versus the JPY.
Expectations can only take the Greenback so far, and eventually investors will need to see action. Consistent improvements in US Nonfarm Payrolls figures suggest the coming week’s result will further build the case for Fed rate hikes. Yet fundamental risks seem weighed to the downside as few predict that hiring matched the impressive pace seen through January’s report.
Technical forecasts paint a similarly mixed picture for the Dollar/Yen exchange rate, and indecision helps explain why recent CFTC Commitment of Traders data shows speculative JPY-short positions (USDJPY-longs) have fallen to their lowest since November, 2012.
It’s certainly possible that strong US economic data could force a larger break higher in the USDJPY. As far as probabilities go, however, we put relatively low odds on a sustained US Dollar move higher in the week ahead.
GBP/USD Stalls at Key Juncture - Outlook Hinges on BoE, NFP
Fundamental Forecast for British Pound: Neutral
The Bank of England’s (BoE) March 5 interest rate decision may have a limited impact on GBP/USD as the central bank is widely anticipated to retain its current policy, but the fundamental developments coming out of the U.K. may continue to boost the appeal of the sterling should the data prints highlight an improved outlook for growth and inflation.
Following the BoE testimony, it seems as though the Monetary Policy Committee (MPC) will continue to move towards a rate hike especially as Governor Mark Carney only sees a ‘temporary’ decline in U.K. inflation and retains the hawkish forward-guidance for monetary policy. With that said, a further pickup in U.K. Mortgage Approvals along with a faster expansion in the Purchasing Manager Indices (PMI) may boost interest rate expectations as a growing number of central bank officials show a greater willingness to normalize monetary policy over the near to medium-term.
At the same time, the U.S. Non-Farm Payrolls (NFP) report will also largely be in focus as it remains a race between the Fed and the BoE as to who will be the first to normalize monetary policy. Indeed, another 240K expansion in U.S. employment may further the argument for a mid-2015 rate hike, but Chair Janet Yellen and Co. may ultimately share a similar fate to their U.K. counterpart especially as Average Hourly Earnings are expected to narrow to an annualized 2.1% in February. As a result, the disinflationary environment may push the Fed to further delay its normalization cycle, while a pickup in U.K. economic activity may underpin a larger rebound in the British Pound as the central bank continues to prepare households and businesses for higher borrowing-costs.
Nevertheless, the lack of momentum to push and close above the former support zones around 1.5510-55 may produce range-bound prices in GBP/USD ahead of the key event risks, but the pair may make a more meaningful effort to retrace the decline from the previous year should the fundamental developments sway the interest rate outlook for the U.S. and U.K. As we open up the March trade, the opening monthly range may dictate the short-term outlook for the pound-dollar as the Fed is scheduled to deliver its next interest rate decision on March 18.
Gold 1195 Support Remains Paramount Ahead of March Opening Range, NFP
Fundamental Forecast for Gold:Neutral
Gold prices snapped a four week losing streak with the precious metal rallying 1.27% to trade at $1216 ahead of the New York close on Friday. The fresh batch of central bank rhetoric from the Humphrey-Hawkins testimony suggests that the Fed remains cautiously on course to normalize monetary policy, but the fundamental developments due out in the days ahead may heavily influence interest rate expectations as the central bank struggles to achieve its 2% target for price growth.
Beyond the slew of central bank rate decisions kicking off the March trade (RBA, ECB, BoE & BoC), the U.S. Non-Farm Payrolls report may have the biggest implications for gold on the back of the USD strength story. Despite the stronger-than-expected 4Q GDP print, the disinflationary environment may put increased emphasis on the wage growth figures due out on Friday, and signs of subdued household earnings may undermine the bullish sentiment surrounding the dollar especially as market participants anticipate Average Hourly Earnings to narrow to an annualized 2.1% in February. We’ll look for possible softness in the greenback to further support the recent gold rally with prices closing out the week just below key resistance.
Last week we highlighted key technical support at $1196/98, a level defined by “the confluence of the 61.8% retracement of the November advance & the 1.618% extension of the decline off the January high and is backed closely by a basic trendline support off the November low. We’ll reserve this region as our near-term bullish invalidation level and although the broader bias remains weighted to the down-side, near-term this structure may offer stronger support. Interim resistance (near-term bearish invalidation) stands at $1218/24… Bottom line: looking for a low early next week with a general topside bias in play near-term while above $1196/98.” - Indeed the market fell to a fresh low on Monday before rebounding to test the $1218/24 resistance range. Our outlook remains unchanged heading into March with the 1196-1224 range in focus to start the week. A topside breach keeps the long-bias in play targeting resistance objectives at 1234 & 1248/50 with a break sub 1195 (close basis) risking substantial declines into subsequent support targets at $1171 & $1155.
Swiss Franc Opportunities Seen Beyond Breakneck Volatility
Fundamental Forecast for Swiss Franc: Neutral
SNB Shocker Fuels Highest Swiss Franc Volatility vs. Euro Since 1975
Sharp Counter-Swing Seen Ahead if ECB Delays Launching QE Effort
Buying US Dollar vs. Franc Attractive After Post-SNB Turmoil Settles
The most adept of wordsmiths might be forgiven for struggling to find an adjective strong enough to describe last week’s Swiss Franc price action. A quantitative description is perhaps most apt: realized weekly EURCHF volatility jumped to the highest level since at least 1975, swelling to nearly 2.5 times its previous peak.
The surge was triggered after the Swiss National Bank unexpectedly scrapped its three-year-old Swiss Franc cap of 1.20 against the Euro, saying the “exceptional and temporary measure…is no longer justified.” Appropriately enough, the previous historical peak in weekly EURCHF activity occurred in September 2011 when the Franc cap appeared as suddenly as it vanished. Then too, the SNB acted without warning and sent markets scrambling.
The announcement caught the collective FX space by surprise. Even the world’s top international economic bodies were apparently left in the dark. IMF Managing Director Christine Lagarde quipped that she found it “a bit surprising” that SNB President Thomas Jordan did not inform her of the impending move. “Talking about it would be good,” she added.St. Louis Fed President Jim Bullard hinted the US central bank was not notified either.
The go-to explanation for the SNB’s actions centers around bets that the ECB will unveil a “sovereign QE” program following its policy meeting on January 22. Mario Draghi and company finally secured a green light for large-scale purchases of government debt after the ECJ gave clearance to the similar OMT scheme devised (but never used) to battle the debt crisis in 2012. The SNB presumably scrapped the Franc cap to avoid having to keep pace with the ECB’s efforts.
Another wave of Franc volatility may be ahead next week. While markets seem all the more convinced that an ECB QE announcement is in the cards after the SNB’s about-face maneuver, a delay in the program’s implementation (if not its formulation) is entirely plausible. Securing the acquiescence of anti-QE advocates like Germany to having such an effort in the arsenal is not the same as launching it. The ECB may yet opt to wait through the end of the first quarter as it has hinted previously before pulling the trigger, sending the Euro sharply higher.
Measuring the fallout from the SNB’s actions is likely to be protracted. The full breadth of the various ripple effects will probably emerge over weeks and months, not hours and days. The Franc now looks gravely overvalued against currencies whose central banks are set to tighten policy this year, with the US Dollar standing out as particularly notable. It seems prudent to let the dust settle before taking advantage of such opportunities however.
Australian Dollar Looks to RBA Rate Decision to Break Deadlock
Fundamental Forecast for Australian Dollar: Neutral
RBA Rate Decision to Trigger Volatility on 50/50 Expectations Split
US Payrolls Outcome to Complicate Aussie Dollar Follow-Through
Identify Critical Australian Dollar Turning Points with DailyFX SSI
The Australian Dollar spent a fourth week in consolidation having started the month with a drop to the lowest level in nearly six years against its US counterpart. That move was triggered by a surprise interest rate cut from the Reserve Bank of Australia, and prices have since stalled as investors weigh the possibility of further easing. The deadlock is likely to be broken in the week ahead as policymakers gather for another policy meeting.
A survey of 29 economists polled by Bloomberg is narrowly leaning toward stimulus expansion, with 18 of those queried calling for the benchmark lending rate to be lowered by 25 basis points to 2 percent. Traders are bit more dubious: priced-in expectations reflected in OIS rates reflect a 56 percent probability of a reduction. This means that regardless of which direction the RBA opts to take, nearly half of investors will find themselves wrong and scrambling to readjust portfolios accordingly. Needless to say, this is likely to make for a volatile response no matter what outcome ultimately hits the wires.
Whatever the initial reaction however, follow-through will be far from certain as high-profile event risk emerges on the external front and threatens to pull the Aussie into its orbit. February’s US Employment report stands out as particularly critical as investors continue to speculate about the timing of the first post-QE interest rate hike from the Federal Reserve. Expectations call for a slight slowdown in job creation, with payrolls posting a 235,000 increase compared with 257,000 added in the prior month.
US news-flow has tended to underperform relative to forecasts in recent months, hinting economists continue to overestimate the vigor of the world’s largest economy and opening the door for a disappointing jobs figure. Such a result may pour cold water on bets calling for the onset of FOMC policy normalization by mid-year. That is likely to weigh on the US Dollar, offering a lift to the Australian unit that either cuts short weakness or amplifies strength seen after the RBA announcement, depending how Glenn Stevens and company ultimately decide to proceed.
New Zealand Dollar May Rise as RBNZ Maintains Hawkish Rhetoric
Fundamental Forecast for New Zealand Dollar: Neutral
Soft 4Q CPI Fuels Dovish Shift in Markets’ New Zealand Policy Bets
NZ Dollar May Rise as RBNZ Rhetoric Maintains Hawkish Overtones
Help Find Key New Zealand Dollar Turning Points with DailyFX SSI
Deterioration in the outlook for monetary policy sent the New Zealand Dollar sharply lower last week. The currency fell nearly 2.6 percent on average against its leading counterparts, making for the worst five-day performance since August 2013. A dismal set of CPI figures was a leading catalyst behind the selloff. The benchmark year-on-year inflation rate fell to 0.8 percent in the fourth quarter, missing economists’ expectations for a print at 0.9 percent and marking the weakest reading in 1.5 years. The outcome weighed heavily on interest rate expectations: a Credit Suisse gauge tracking the priced-in 12-month policy outlook now shows investors are leaning toward easing for the first time since December 2012.
The markets will not have to wait long to see if their newfound dovish outlook holds water as the RBNZ prepares to deliver its policy announcement in the week ahead. The priced-in probability of a change in the baseline lending rate this time around is nil. Economists generally agree: all 15 of them polled by Bloomberg predict the central bank will stay put at 3.50 percent. That will place the spotlight on the policy statement accompanying the rate decision, with traders readying to comb through the document for language telegraphing where Governor Graeme Wheeler and company intend to steer from here.
December’s RBNZ statement was interpreted to be decidedly hawkish. Mr Wheeler seemed sanguine about weakness on the export side of the equation, citing strong domestic demand. Growth was seen at or above trend through 2016, which the RBNZ chief said meant that “some further increase in [interest rates] is expected to be required.”When the Kiwi dutifully rallied on the statement, Wheeler seemed at a loss, saying in the press conference following the policy announcement that he was surprised at the currency’s reaction. For their part, market participants seemed surprised at his surprise, wondering what policymakers thought a currency ought to do if not advance when the central bank signals tightening ahead.
Looking ahead to January’s outing, this could make for a curious outcome. New Zealand economic news-flow has continued to improve relative to consensus forecasts since December’s meeting, according to data from Citigroup. This has occurred even as the price for the country’s dairy exports – the largest component of the external sector – slid to the lowest level since August 2009. That suggests December’s narrative about domestically-led growth remains largely unchanged. Meanwhile, Statistics New Zealand – the government agency that produces CPI figures – chalked up the fourth-quarter slump to sinking oil prices. If the RBNZ dismisses ebbing price growth as transitory on this basis (much like the Federal Reserve, for example), their hawkish posture may remain unchanged.
Such an outcome will clash with the markets’ dovish-leaning sentiments, sending the Kiwi sharply higher.
One might suspect the RBNZ would play to investors’ leanings and encourage depreciation considering its long-standing duel with the exchange rate. In fact, it has become difficult to remember a month in which policymakers did not bemoan the “unjustifiably and unsustainably high” exchange rate in official communications, foretelling “significant depreciation” ahead.Given last month’s surprise at how FX responds to central bank rhetoric however, that may be too fancy a strategy to bet on.