Dollar and S&P 500 Traders Hold Breath for Fed Decision
Fundamental Forecast for Dollar:Bullish
The Fed rate decision is this week’s top event risk following a dovish shift recently for the ECB, BoE and BoC
Can the Fed maintain its drive towards its first rate hike in 2015 when the rest of the world is loosening the reins?
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In the past few weeks, we have seen a nearly universal dovish shift in global monetary policy. The ECB, BoE, BoJ, BoC and other central banks have offered up either actions or commentary that is tangiably more accommodative in its policy slant. This is reaction to cooler global growth winds, stagnant inflation pressures and perhaps even in response to an unofficial currency war. Yet, through this broad effort to head off economic trouble and financial crisis, there is one policy body standing firmly on the opposite end of the spectrum: the Fed. Can the US central bank continue to carve such a divergent path? And, what does this mean for the Dollar and capital markets?
When the scope of a market is international – as the FX market is – capital flows are driven by relative demand along national borders. The relative appeal of the US market and Dollar has grown exceptional over the past six months. Taking the temperature of the developed and emerging world’s health, we have seen economic forecasts – recently refreshed by the IMF’s WEO – downgraded. Meanwhile, the US was one of the few that continues to win upgrades. That bodes well for investor returns when market participants are still vying for higher yield even as confidence wavers.
A direct measure of returns itself, monetary policy is also leaning heavily in the Dollar’s favor. Working off the Fed’s remarks that a move towards normalization was justify as recently as the last FOMC minutes, there is a hawkish (if moderate) intention from the US authority. This represents a particularly dramatic contrast in the global scales following the introduction of a new, large-scale stimulus program from the ECB this past week. But it isn’t just the ECB that is on a sharply divergent path. The BoJ is maintining its own QQE program (recently upgraded in October), the BoE minutes showed hawks quieted their voice at the last meeting, the BoC surprised with a rate cut, the SNB failed to hold its EURCHF floor, and the RBA tipped back from neutral to dovish rhetoric.
The question that should be on traders’ minds this week is whether or not the Fed can maintain its push towards the eventual rate hike when the rest of the world is reverting to accommodation. Given a rise swell of cross-asset volatility these past months, the ECB’s dramatic moves and semi-regular shocks in the headlines; it would seem that a softening of stance would be likely. However, many of these issues were already in play or expected during the last meeting when the Fed gave its optimistic remarks. In the US, conditions continue to show considerable improvement (even if it is slow) without financial shocks that instigated the unorthodox policy in the first place. What’s more, there is an opportunity one of the primary players in the global central bank community to make a move to normalize under relatively steady conditions with a backdrop where other major participants are readily offsetting the possible negative rammifications.
When the Fed meets on Wednesday, the primary question is whether the group maintains its tone to fuel speculation of a ‘mid-2015’ rate hike. That doesn’t require pre-commitment nor any rhetoric materially more hawkish than the last gathering. Rather, the market needs to simply see a lack of dovish cues in the monetary policy statement. If that is the case, the Dollar’s rate bearing will push it even farther off course of its counterparts.
Beyond, the forward rate advantage traders will be looking to glean from the event, the broader market will also measure the sentiment impact this event holds. If the Fed doesn’t push back a hike to 2016, it can upset a carefully crafted status quo and stimulus-smoothed investment environment. In other words, a ‘hawkish’ Fed generate risk aversion sentiment and perhaps finally turn holdout speculative benchmarks (like the S&P 500 and US equities) lower. If that is the case, the Dollar could also gain on a safe haven / liquidity bid.
EUR/USD Risk Triumvirate to Keep Volatility Elevated This Week
Fundamental Forecast for Euro: Neutral
- Expectations for the ECB’s QE program were established on Wednesday after a ‘leak’…
- …but ECB President Draghi delivered, and the new QE program lived up to thepre-announcement hype.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
The Euro’s beating continued last week, with fresh 11-year lows coming against the US Dollar after the European Central Bank unveiled its much-anticipated QE program. EURUSD closed the week down a whopping -3.24% at $1.1203 while EURJPY closed down by -3.01% at ¥131.95. Volatility measures have swelled the past few days, and there is little indication that sharp price swings will abate anytime soon: the Euro has three very strong influences driving price right now.
The first component of the risk triumvirate would of course be the ECB’s historical decision to open up its balance in order to attempt to buoy inflation expectations. Since early-November, we’ve heard ECB President Mario Draghi discuss the desire to boost the ECB’s balance sheet back to its early-2012 levels. At €2.16 trillion for the week ended January 16, the balance sheet is still roughly €1 trillion short of its peak in the first half of 2012. The ECB’s QE program at €60bn/month will accomplish this by Q3’16. But this is not the main takeaway from the ECB’s monumental decision; rather, the fact that the program is open-ended means it is significantly more aggressive than the assumed ‘through the end of 2016’ that was first floated the day before the ECB’s meeting this week.
Market participants have priced in a good deal of the easing expectations; but with real yields low, the Euro is essentially a funding currency at this point in time, not a growth currency. Inflation expectations continue to tumble, as measured by the 5Y5Y inflation breakevens, but this is not a great indicator anymore: the ECB’s new program will include purchases of inflation linkers. So, falling expectations are a component of market participants front-running the commencement of the QE program in mid-March.
Sliding bond yields and elevated equity indices serve as a good indication of the ECB’s dovish move. The question henceforth is: how optimistic are market participants that the aforementioned measures will revive the region’s flagging growth and disinflationary spiral? When the Fed implemented its QE programs, the US Dollar slid rapidly into the announcements, but bottomed quickly thereafter as traders began pricing in the impact of QE: an improved economic environment.
For the Euro, finding a bottom might not be so easy to achieve in the near-term. The second member of the risk triumvirate, the Greek elections, have brought a new element into the equation: the far-left, anti-bailout Syriza party in as the custodians of the Greek government. Syriza leader and likely Greek Prime Minister Alexis Tsipras has voiced his desire to renegotiate Greece’s debt burden, and German officials have been more open than in the past to a potential debt restructuring deal. The rise of an anti-bailout party poses a real threat to the current construct of the Euro-Zone: will Greece leave and reintroduce the Drachma?; or will Germany say ‘enough is enough’ and call it quits amid the rising cost of saving the Euro-Zone? Neither is a palatable outcome for the Euro.
Between the ECB’s QE program and the Syriza victory, there is good reason why traders may treat the Euro with hostility in the coming weeks. But a third wrinkle emerges this week: the Federal Reserve’s own policy meeting. This may be the best opportunity for the Euro to rebound. Market measures (the Fed funds rate and overnight index swaps (OIS)) now point to a Q4’15 rate hike from the Fed, far more dovish than what the Fed’s dot plot suggested just last month.
With a large Euro short position in the futures market – speculators currently hold 180.7K net-short contracts, the most since the week ended June 5, 2012 (195.2K) – and a five-year higher in long-end (10Y+) US Treasury shorts, there is a powder keg mid-week in the FOMC meeting that offers a ray of hope for Euro bulls. Without a dovish Fed, however, hope for the Euro rests solely on incoming data, evidence that growth is returning and no more QE is down the road. There are few guarantees in life; but the Euro’s risk triumvirate of the ECB’s QE program, the Greek elections, and the FOMC meeting should keep volatility elevated for the foreseeable future. –CV
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Bullish USD/JPY Outlook Vulnerable to Less-Hawkish Fed, Dismal US GDP
Fundamental Forecast for Japanese Yen: Neutral
The fundamental developments due out next week may undermine the bullish forecasts surrounding USD/JPY should the Federal Open Market Committee (FOMC) scale back its hawkish tone for monetary policy.
Despite growing expectations for a Fed rate hike in mid-2015, the rotation within the voting committee may spur a material shift in the forward-guidance for monetary policy, and the central bank may sound increasingly cautious this time around amid the fresh batch of monetary support from the Swiss National Bank, European Central Bank and Bank of Canada. Indeed, the Fed may not way to get too far ahead of its major counterparts as it struggles to achieve the 2% target for inflation, and Chair Janet Yellen may show a greater willingness to further delay the normalization cycle especially as the advance 4Q Gross Domestic Product (GDP) report is expected to show the economy growing an annualized 3.2% versus the 5.0% expansion during the three-months through September.
At the same time, Japan’s Consumer Price Index (CPI) may also fail to encourage a bullish outlook for USD/JPY as the Bank of Japan (BoJ) continues to endorse a wait-and-see approach for monetary policy, and the pair remains at risk for a larger correction over the near-term as Governor Haruhiko Kuroda remains confident in achieve the 2% inflation target over the policy horizon. In turn, USD/JPY may continue to carve a sting of lower-highs going into February should the data prints drag on Fed interest rate expectations.
With USD/JPY struggling to push back above the 119.00 handle, the pair faces a risk for move back towards near-term support around the 117.00 handle, and the dollar-yen may make a more meaningful run at the January low (115.84) should the bullish sentiment surrounding the greenback fizzle.
British Pound Likely to Rally if Critical US FOMC Meeting Disappoints
British Pound Likely to Rally if Critical US FOMC Meeting Disappoints
Fundamental Forecast for GBP: Neutral
A negative surprise from the Bank of England helped push the British Pound lower for the sixth-consecutive week versus the US Dollar. Extremely stretched price action raises the risk of a short-term bounce, but what could reasonably force the Sterling higher?
The seemingly-unstoppable US Dollar clearly remains in control against major counterparts, and the British Pound is no exception. UK economic event risk will be relatively limited in the week ahead and offers little hope of a news-driven GBP reversal. Instead traders will likely remain focused on a highly-anticipated US Federal Open Market Committee (FOMC) policy decision on the 28th. Any surprises could have far-reaching effects across FX and broader financial markets.
Unprecedented Quantitative Easing from the ECB, negative interest rates from the SNB, and expectations of unchanged monetary policy from the Bank of England makes the US FOMC stand out from the crowd. Unlike its G10 counterparts, markets expect the US Federal Reserve could soon raise interest rates. The key divergence helps explain why the US Dollar has significantly outperformed most major currencies through recent price action, but the risk of a sharp Dollar correction is especially high.
A disappointing US Federal Reserve decision could force a substantial Dollar pullback, and we believe the British Pound could outperform on such a USD correction. UK economic fundamentals and interest rate expectations may be relatively lackluster in the absolute sense. Yet relative to the likes of the Euro, Swiss Franc, and other majors, we believe the Sterling stands to do well absent further deterioration in domestic inflation figures.
Traders should use limited leverage ahead of what promises to be an important FOMC decision in the days ahead. Reversal risk is high as positioning data shows large traders are heavily long the US Dollar. It may take little to force a significant correction. - DR
--- 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.
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Gold Rally Fizzles Ahead of FOMC, US GDP- 1263 Key Support
Fundamental Forecast for Gold:Neutral
Gold prices are higher for a third consecutive week with the precious metal rallying 0.91% to trade at $1292 ahead of the New York close on Friday. Gold has remained well supported as concerns over a global economic slowdown and a flurry of unexpected central bank policy shifts saw inflows into the US Dollar and bullion. While the luster of gold seems to be gaining appeal, near-term the trade has come into a significant area of resistance ahead of major US metrics next week.
Given the slew of major surprises from global central banks, traders will be closely eyeing key US data prints next week with Durable Goods Orders, New Home Sales, Q4 GDP and the highly anticipated FOMC Interest Rate Decision on tap. Gold may continue to catch a bid in the coming days should the Federal Reserve interest rate decision further dampen the appeal of fiat currencies in light of the fresh wave of easing measures from SNB, ECB, and BoC. The high level of uncertainty surrounding the monetary policy outlook may continue to heighten the appeal of the bullion.
Despites expectations for a Fed rate hike in mid-2015, the new rotation within the voting committee may drag on interest rate expectations, especially as we lose the two hawkish dissenters from 2014 (Richard Fisher & Charles Plosser). As a result, the fresh vote count combined with a weakening outlook for global growth may undermine the bullish sentiment surround the greenback and boost demand for alternative stores of wealth should the FOMC talk down bets for a rate hike this year.
Last week we noted, “Look for a pullback early next week to offer favorable long-entries with the near-term outlook weighted to the topside while above $1248. A breach above resistance targets the 76.4% retracement of the July decline at $1294 and the upper median-line parallel of the November advance, currently just above the $1300-mark.” Gold remains within the confines of a well-defined ascending pitchfork formation off the November lows with this week’s rally coming into resistance at the upper median-line parallel, currently around $1307. Longs are at risk below this mark near-term with the broader bias remaining weighted to the topside while above $1263. Look for a pullback next week to offer favorable long entries with a breach of the highs targets resistance objectives at $1320/21, the July high-day close at $1335 and $1345.
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.
Aussie Dollar Aims Higher on Shift in RBA vs. Fed Policy Outlook
Fundamental Forecast for Australian Dollar: Bullish
Aussie Dollar to Rise if Jobs Data Cools RBA Rate Hike Speculation
Soft US CPI, PPI Results to Undercut Fed Outlook and Boost AUD
Help Find Key Australian Dollar Turning Points with DailyFX SSI
The Australian Dollar will have to balance competing forces in the week ahead, with a dose of potent home-grown economic data vying for influence alongside macro-level crosscurrents. On balance, the currency seems likely to continue to recover having started the year at the lowest in over five years against its US counterpart.
Domestically, the spotlight will be on December’s Employment report. Expectations suggest the economy added 5,000 jobs last month, amounting to the weakest reading in three months. Australian economic news-flow has notably improved relative to consensus forecasts over the past four weeks however, suggesting economists are underestimating the economy’s momentum and opening the door for an upside surprise.
Such an outcome may pour cold water on building RBA interest rate cut speculation. Indeed, a gauge of the implied outlook reflected in OIS pricing points to at least one 25bps reduction in the baseline lending rate over the next 12 months and has been creeping closer toward calling for two over recent weeks. A jobs report that pushes back against this dynamic is likely to offer support to the Australian Dollar.
On the external front, US data will be in focus. The response to December’s payrolls data suggests that – with only a handful of exceptions – FX markets are splintering away from broader sentiment trends. The parallel declines in the S&P 500 and the US Dollar apparently triggered by soft wage growth readings hint the former is concerned with global growth trends while the latter is focused specifically on the Fed policy outlook.
US retail sales, inflation and consumer confidence figures as well as the Fed’s Beige Book survey of regional economic conditions are all due to cross the wires in the coming days. The growth side of the equation looks mixed considering the Fed’s assessment is likely to take a balanced view and sentiment is seen firming while retail activity is expected to slow. Though this casts a cloud of uncertainty over sentiment trends, the FX picture looks clearer as soft price growth undercuts Fed rate hike bets, sending AUDUSD higher.
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.