Dollars Six-Month Bull Trend Rides on FOMC
Fundamental Forecast for Dollar:Neutral
The FOMC rate decision this week is the quarterly event that comes stocked with updated forecasts and a Yellen presser
Year-end portfolio rebalancing may find FX traders over-extended on Dollar exposure
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The Dow Jones FXCM Dollar Index (ticker = USDollar) dropped this past week for the first time since the mid-October, market-wide slump. At the same time, the S&P 500 suffered its worst tumble since mid-2012. This hefty decline in capital markets and subsequent swell in volatility measures has the look-and-feel of a broad risk aversion move. This correlation between what is traditionally considered a safe haven currency and the financial system’s most stubborn speculative beacon (US equities) has many calling the Greenback a ‘risk’ currency at the same time anxiety over systemic risk aversion sets in. With a vested interest in risk trends and a high-profile FOMC rate decision ahead, plan for a potentially volatile week for the Dollar.
While the Fed meeting will be top event risk for both the US currency and broader markets, it will be important to get the lay of the land heading into the release. In particular, the steady rise in implied volatility (expected price swings) alongside the uniform retreat in growth and yield-dependent assets has many market participants unnverved. Historically, there is a seasonal effect that sees the S&P 500 climb (averaging 1.9 percent) and volume drain to its lowest level of any month according to data going back to 1990. While it may not be difficult to deviate from the so-called ‘Santa Claus’ rally, it is difficult to overcome the liquidity exit. It would take heavy fundamental and price-based change to motivate traders to remain active.
If we fall short of the full-scale risk aversion pace, a correction from the Dollar and US equities would reflect a natural moderation of one-sided markets – not particularly surprising given the former’s five-month rally to multi-year highs and the latter’s incredible six-week surge (a record breaking 29 days above the 5-day moving average) to record highs. Left undisturbed, a further retreat for both would be highly likely. Yet, given the items on the docket ahead, it is unlikely to be a quiet moderation.
In terms of volume, there are plenty of speculative-worthy updates ahead. The focus, however, will be set on a single event: the FOMC rate decision. This is one of the ‘quarterly’ meetings where the regular decision on rates and unorthodox policies as well as the monetary policy statement will be accompanied by updated forecasts (growth, inflation, employment and – most important of all – intrest rates) and Fed Chairwoman Janet Yellen’s press conference. There will be two particular elements to this event which traders will be watching: a change to the interest rate consensus and what will be done with the ‘considerable time’ language.
The infamous ‘dot plot’ has fueled plenty of hawkish speculation – particularly with the last update in September. The consensus forecast for the benchmark lending rate was 1.38 percent through the end of 2015. To reach that level and still conform to the expected ‘mid-2015’ first hike, the Fed would have to practically raise rates through each of the policy meetings in the second half of the year. That seems aggressive given current inflation forecasts and the specter of cooler global growth trends seeping into the US. As such, a moderation of this aggressive clip is likely. But, how market-moving would it be? Fed Funds and Eurodollar futures are already significantly discounting the rate move (pricing in approximately 50 bps worth of hikes through year’s end).
The other key aspect of the meeting will be the ‘considerable time’ language that has been repeated in the accompanying statement for over two years. This phrase is considered a buffer zone whereby each time it is revisited, the market expects at least another six months without a hike. A few Fed officials – including Yellen – reinforced that particular time frame this past year. In the past few months, officials have weighed in on dropping it from the text. If we don’t see it, the market will set its countdown for six-months (June 18 meeting). Yet, here too, a ‘mid-2015’ hike has been a well-priced mantra. What matters more: the first move or the pace?
Positioning Unwind May be Driving Factor, Not QE, for Euro
Fundamental Forecast for Euro: Neutral
- The technical prospects of a top in the US Dollar (vis-à-vis the USDOLLAR Index) have accumulated the past week.
- EURUSD and USDCHF wedges hint at possibility of bottoms in European FX starting to take shape.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro stabilized in the second week of December, just a few days after hitting fresh yearly lows below $1.2250 against the US Dollar. EURUSD closed on Friday with a five-day gain of +1.44%, finishing the week at $1.2459. The 18-member currency only closed lower versus the Japanese Yen, with EURJPY declining by -0.81% to ¥147.95. Although chatter regarding a potential QE program from the European Central Bank has only increased in the wake of its December 4 meeting, the combination of year-end portfolio rebalancing and overstretched short positioning may be contributing to the recent rebound.
For several months, the futures market has been stretched with net-short Euro positions. Peak bearishness was evident in early-November, when traders were net-short to the tune of 179.0K contracts for the week ended November 4. As of December 9, short positions were being lifted, contributing to the recently choppy rate of decline, having eased to 136.9K contracts. Herein lies the longer-term hope for bears: even as short positions abated from November 4 to December 9, EURUSD has still managed to decline by -1.37%.
Even if any upward drift in recent days is the result of further short covering – something we won’t have definitive proof of until the next release of the CFTC’s Commitment of Traders report on December 19 – traders need to be aware of this threat into trading conditions around the holidays. Overarching fundamental themes of 2014 could lose gravitational pull on price as traders’ anxiety to close their books builds.
Although economic conditions have moved off the low, the Euro-Zone remains in an economic state on the verge of its third recession since the financial crisis began in 2008. The Citi Economic Surprise Index closed the week at -20.3, barely changed from the prior weekly close on Deecmber 5 at -21.4, and little changed overall over the past month, when the index was at -26.4 on November 14.
The greatest source of distress that should hold back market participants from helping the Euro set anything other than a short-term bottom is the ongoing pressure in medium-term inflation expectations. The 5Y5Y breakeven inflation swap, ECB President Mario Draghi’s purported preferred market measure of medium-term inflation expectations, slumped to a new yearly low. The gauge fell as low as 1.364% on Friday and closed the week at 1.377%.
With inflation expectations still disparingly low, the ECB’s doves will continue to chirp about a potential QE program, which should be a big enough threat to keep a major Euro rally from commencing. Several policymakers have stated their desire to see the ECB’s balance sheet move back towards its early-2012 levels (roughly €2.6 to €3.1 trillion), and there are few signs that the current measures are accomplishing just that: as of December 5, the ECB’s balance sheet stood at €2.04 trillion, barely higher than the €2.01 trillion it was three-months earlier. Euro bulls shouldn’t get too comfortable just yet. –CV
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USD/JPY Outlook to Remain Bullish on Fed, BoJ Policy Divergence
Fundamental Forecast for Japanese Yen: Neutral
The near-term outlook for USD/JPY remains mired by Japan’s December 14 snap election, but the ongoing deviation in the policy outlook should continue to produce a further advance in the exchange rate as a growing number of Fed officials show a greater willingness to normalize monetary policy in 2015.
Despite the risk for a material shift in fiscal policy, recent headlines suggests ‘Abenomics’ will continue to influence the Japanese Yen in the year ahead as the Liberal Democratic Party (LDP) is widely expected to retain majority in the lower-house of the National Diet. As a result, the Bank of Japan (BoJ) may continue to highlight a dovish outlook for monetary policy at the December 19 meeting, and Governor Haruhiko Kuroda may keep the door open to further expand the asset-purchase program as the technical recession undermines the central bank’s scope to achieve the 2% target for inflation.
In contrast, there’s growing speculation the Federal Open Market Committee (FOMC) will remove the ‘considerable time’ phrase and implement a more hawkish twist to the forward-guidance as lower energy costs boost disposable incomes for U.S. households. The improved outlook for personal consumption – one of the leading drivers of growth – may encourage the Fed to boost its economic and interest rate projections as the central bank anticipates a stronger recovery in 2015. With that said, the bullish sentiment surrounding the greenback may gather pace over the remainder of the year should the fresh developments coming out of the FOMC heighten interest rate expectations.
In turn, the fundamental outlook continues to cast a long-term bullish outlook for USD/JPY, and we will retain the approach to buy-dips in the exchange rate unless there’s a meaningful change in fiscal/monetary policy. Dollar-yen appears to be coiling for a move higher as it holds above the 117.00 handle, with the next key topside objective for USD/JPY comes in around 122.30-40, the 78.6% Fibonacci retracement from the 2002 decline.
British Pound May Finally Mount a Sustained Recovery versus USD
Fundamental Forecast for Pound:Neutral
The British Pound finished the week modestly higher but continued to trade in a tight range versus the US Dollar. A busy week ahead threatens to force a decisive break in the GBPUSD and other pairs.
The simultaneous release of UK Jobless Claims and Earnings data with Bank of England Minutes will likely prove the highlight in the days ahead, and GBPUSD traders should likewise keep a close eye on a highly-anticipated US Federal Reserve interest rate decision that same day. Earlier-week UK Consumer Price Index inflation figures as well as late-week UK Retail Sales results could also elicit reactions from GBP pairs.
Whether or not the Sterling mounts a sustained recovery versus the US Dollar will likely depend on the direction of interest rate expectations for both the Bank of England and the US Federal Reserve. A sharp compression in the spread between UK and US government bond yields helps explain why the British Pound fell to fresh 14-month lows versus the Greenback through November. Yet a great deal of uncertainty surrounds both the Fed and BoE; any surprises out of the coming week’s economic data and central bank rhetoric could easily force a repricing of yields and the GBPUSD exchange rate.
The US Dollar in particular looks vulnerable on any disappointments from the Federal Reserve, and indeed the previously-unstoppable USD finally showed concrete signs of slowing through the past week of trade. And though the Sterling could itself see fairly significant volatility on UK event risk, we expect that the overall US Dollar trend will ultimately dictate whether the GBPUSD makes a sustained recovery.
Gold Rally Vulnerable to Hawkish FOMC - $1237 Key Resistance
Fundamental Forecast for Gold:Neutral
Gold prices are markedly higher this week with the precious metal rallying 2.5% to trade at $1222 ahead of the New York close on Friday. The advance comes amid a turbulent week for broader risk assets with global equity markets selling off sharply on global growth concerns. Weakness in the US Dollar and falling crude prices have further impacted risk appetite with gold well supported as investors sought alternative stores of wealth. Despite the gains however, prices continue to hold below a key resistance threshold with the near-term risk weighted to the downside heading into next week.
It was a rough week for equities with the SPX off more than 2.70% on the week as growing political uncertainty in Greece and concerns over the weakening outlook for global growth sparked a wave of profit taking. The accompanied sell off in crude prices, which hit lows not seen since 2009 on Friday, have continued to weigh on broader market sentiment, with gold catching a bid early in the week.
Looking ahead to next week, US economic data comes back into focus with the November Consumer Price Index and the highly anticipated FOMC policy decision on Wednesday. As officials anticipate weaker energy prices to boost disposable incomes for U.S. households, the recent pickup in job/wage growth may embolden the committee to take a more hawkish stance on monetary policy with speculation circulating that the central bank may look to remove the “considerable time period” language as it pertains to interest rates. Should the subsequent presser and updated growth projection show a more upbeat assessment, gold could come under pressure as investors begin to bring forward interest rate expectations. That said, the trade remains vulnerable near-term just below key resistance.
From a technical standpoint, gold has now pared 50% of the decline off the July high with the move into the $1237 target we noted last week . This level converges with a median line dating back to August 2013 and near-term the risk remains weighted to the downside while below this threshold. A breach above targets subsequent targets at $1248 and a key resistance range at $1262/68. Interim support rests at $1206 and $1196 with only a move sub-$1179/80 shifting the broader focus back to the short-side. Bottom line: longs at risk near-term sub $1237 with a pullback likely to offer more favorable long-entries lower down. A breach of the highs keeps the topside bias in play with such a scenario eyeing targets into the 200-day moving average.
Swiss Franc Breach of 1.20 Against Euro Unlikely to See Follow-Through
Fundamental Forecast for Swiss Franc: Neutral
Swiss Franc Faces Pivotal Event Risk as Gold Referendum Looms Ahead
Follow-Through Unlikely on Initial Breach of SNB’s 1.20 EURCHF Floor
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The Swiss Franc has faded into the background as an object of speculation in its own right over recent years. A steady monetary policy centered on a commitment to maintain a EURCHF floor at 1.20 amplified the already significant historical correlation between the Swiss unit and the Euro, largely framing the outlook on the former currency in terms of developments with the latter. This may soon change as EURCHF flirts with breaching the SNB’s defenses on the eve of a crucial referendum whose outcome may be seen as undermining the central bank’s ability to respond.
Switzerland will take to the polls on November 30 to decide on a measure that would require the SNB to maintain 20 percent of its reserves as gold, which it would subsequently not be allowed to sell. The monetary authority would also have to repatriate the gold it owns but stores offshore (largely in the UK and Canada). As of September, the SNB held about 7.6 percent ($38.9 billion) of a total of $530.9 billion in reserves as gold. Using that as a baseline, getting to 20 percent would imply a purchase of an additional $106.2 billion in gold. The latest polling results ahead of the referendum published on October 31 showed 47 percent of respondents were against the initiative, 38 percent were in favor, and 15 percent were undecided.
The Swiss Franc may breach the 1.20 threshold against the Euro in the event of a “yes” vote. This initial response would reflect the newfound complications to maintaining the barrier. To date, the SNB has been able to defend its policy relatively easily because it can effectively “print” as much of its own currency as needed and use it to buy Euros in the market. Growing FX reserves in this way given a 20 percent gold holdings requirement would imply a large parallel purchase of the yellow metal. To avoid undermining their own EURCHF efforts, the SNB would have to use its non-Euro FX holdings to make this purchase. That has raised worries that the floor can only hold while the SNB has the stock of FX needed to maintain it and would eventually give way once reserves run out.
Such concerns seem misplaced. The latest SNB data shows it holds 53.2 percent of its reserves in currencies other than the Euro. The monetary authority has increased its total reserve holdings by an average of CHF7.2 billion per month since the introduction of the EURCHF floor in August 2011. Assuming this pace is maintained and adjusting for the additional outlay needed to bring current gold reserves to 20 percent of the total, the SNB would not run out of ammunition for close to 12 years. Considered together with the 5 years allotted to the central bank in the referendum terms to bring its gold position up to snuff, this means that no radical policy change need necessarily occur if a “yes” vote emerges. In practical terms, this suggests that if EURCHF dips below 1.20 on a short-term basis after the votes are counted, the move is unlikely to mark the beginning of a lasting downturn.
Australian Dollar May Drop Out of Range on FOMC, RBA Minutes
Fundamental Forecast for Australian Dollar: Neutral
Australian Dollar Torn Between Conflicting Year-End Liquidation Forces
FOMC Outcome, RBA Minutes May Break Deadlock and Sink the Aussie
Help Find Key Turning Points for the Australian Dollar with DailyFX SSI
The Australian Dollar finds itself torn between conflicting forces as year-end liquidation on trends dominating markets in 2014 gathers momentum. Swelling risk appetite – embodied by a relentless push upward by the S&P 500 – and a firming US Dollar have been defining themes in the past year. Profit-taking on these trades ahead of the transition to 2015 has produced a parallel downturn in the greenback and the benchmark stock index.
This dynamic carries conflicting implications for AUDUSD. On one hand, the prices are being offered support by a market-wide unwinding of long-USD exposure. On the other, the shedding of risk-on exposure is putting downward pressure on the sentiment-geared Aussie Dollar. Not surprisingly, this produced relative standstill, with prices locked in a narrow range and waiting for guidance even as notable reversals are recorded elsewhere in the anti-USD space.
A shift in the relative monetary policy outlook may break the deadlock in the week ahead. Shifting expectations over recent weeks have delivered a priced-in G10 forecast that sees the RBA as one of the most dovish central banks in 2015. Indeed, with OIS rates implying at least one interest rate cut in the coming 12 months, the Australian monetary authority leads on the conventional policy easing front. Only the BOJ and the ECB may edge out Glenn Stevens and company for the most-dovish crown, and then only via expansions of non-standard measures.
This stands in stark contrast with the policy trajectory at the Federal Reserve. Markets are betting on at least one rate hike in 2015 and have been flirting with the possibility that US officials will be able to squeeze in two of them before year-end. US economic news-flow appears to be gathering steam relative to consensus forecasts once again. Data from Citigroup suggests that, on the whole, realized outcomes are now outstripping expected ones by the widest margin since mid-September. This has already encouraged markets to bet on the sooner arrival of the first post-QE rate hike. Next week’s FOMC policy announcement – this time complete with an updated set of economic projections and press conference from Chair Janet Yellen – may see the timeline shorten further.
On the domestic front, minutes from December’s RBA meeting will be in the spotlight. The markets were not meaningfully swayed against betting on a 2015 rate cut by the neutral statement that emerged out of that sit-down. This suggests that anything but a convincing hawkish rhetorical shift – an outcome that seems overwhelmingly unlikely even on a relative basis – will keep bets on a 25-75 basis point pro-USD move in the policy spread comfortably in place. Taken together with guidance from the Fed, that may tip the scales to produce a bearish break out of consolidation for the Aussie.
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.