US Dollar Targets Fresh Highs versus Euro, but What Could Change?
US Dollar Targets Fresh Highs versus Euro, but What Could Change?
Fundamental Forecast for US Dollar: Bullish
The US Dollar finished at fresh multi-year highs versus the Euro and near key peaks versus other currencies, boosted by a sharp improvement in US interest rate expectations on a highly-anticipated Fed interest rate decision.
We expectsignificantly less volatility in the holiday-shortened week ahead, but traders should be wary of any surprises from revisions to the Q3 US Gross Domestic Product report, US Durable Goods Orders data, and two Home Sales releases. Although admittedly unlikely, any surprises in the third revision to Q3 GDP figures could have a marked effect on US interest rates and the Dollar itself.
The US Dollar jumped alongside short-term yields on this past week’s highly-anticipated US Federal Open Market Committee interest rate decision. Fed officials initially disappointed those who expected a more hawkish shift in policy in the first FOMC meeting since the end of Quantitative Easing in October. Yet short-term treasury yields and implied US interest rates rose sharply as Fed Chair Janet Yellen essentially said that rate hikes could come after as few as two meetings.
The US Dollar continues to track changes in the US 2-year Treasury Yield—a strong proxy for Fed interest rate expectations—with great accuracy. A sharp reversal leaves the 2-year UST yield at more than twice the low it set through October 15—the exact day of the US Dollar low as seen through the Dow Jones FXCM Dollar Index (ticker: USDOLLAR). Since that date, the Greenback has surged a remarkable 11 percent versus the interest-rate sensitive Japanese Yen, 7 percent versus the Australian Dollar, and 5 percent versus the Euro.
US Dollar traders will almost certainly track changes in yields and interest rate expectations, and a key question is whether domestic economic data can continue to impress and send rates and the USD to further peaks. Dollar momentum seems stretched, and economic data can only surpass expectations for so long. Yet the US Dollar remains in an uptrend until it isn’t, and we’ll need to see concrete signs of a turn to call for a meaningful turnaround.
Traders should otherwise keep an eye on developments in the Russian financial crisis and broader Emerging Markets. Many were surprised to see the US S&P 500 track the USD/Ruble exchange rate on a virtual tick-for-tick basis, but the truth is that further destabilization in Russia threatens contagion and carries direct implications for global financial markets.
Contagion risks sent the S&P 500 sharply lower and the flight to safety likewise pushed the US Dollar down versus the Euro and Yen as traders excited USD-long positions in a hurry. Both the Greenback and the S&P recovered sharply into the end of the trading week. Whether or not the Dollar continues higher may subsequently depend on the trajectory of the Ruble and broader financial market risk sentiment. –DR
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Euro Flounders at Yearly Lows as Likelihood of ECB QE Increases
Fundamental Forecast for Euro: Neutral
- EURUSD briefly traded over $1.2500 this week, but the Fed’s hawkish tone bolstered the greenback.
- Surprise SNB action has sparked a new speculative drive in the Euro – is the SNB front-running the ECB?
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
Amid new signs that a massive balance sheet expansion is on the horizon, the Euro plunged quickly in the second half of the week, finishing -1.91% lower versus the US Dollar by Friday’s close. The 18-member currency fell by more than -1% against all of its major counterparts (save the Swiss Franc; EURCHF +0.22% on the week), with EURJPY posting a -1.27% loss despite the ongoing strength in global equity markets. The recent wave of actions and comments from central bank officials inside and outside of the Euro-Zone is feeding into the narrative that the European Central Bank is about to embark on a new QE program.
It’s important to consider the role of the Swiss National Bank over the past several years: it has practically served as an adjunct branch of the ECB, ever since the SNB implemented the Sf1.2000 floor in EURCHF on September 6, 2011. Is it a coincidence, then, that as the ECB grapples with introducing a major QE program at its January 22 meeting and fears of a Russian currency crisis rise, that the SNB has taken steps to deter investors and speculators from fleeing to the Swiss Franc?
In a sense, the SNB’s introduction of negative interest rates for the first time since the 1970s serves as a measure to front run a massive balance sheet expansion by the ECB – this is an attempt to build a cushion against ECB QE-driven speculation that might threaten the EURCHF Sf1.2000 floor.
If the purported purpose of the SNB’s latest surprise actions seem conspiratorial, then comments made by ECB policymaker Benoit Couere may serve to affirm this speculation. Comments issued on December 16 suggests that a new easing program by the ECB is very near, with Mr. Couere saying that “there is a large consensus on the Governing Council to do more and we are now discussing the instruments to use.”
The time for the next wave of Euro weakness may be nearing, now that the futures market has been somewhat relieved of its stretched 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 December16, short positions had fallen to 126.6K contracts – a -29.3% reduction. The positioning shift gives reason for bears to believe in the downtrend: as short positions eased from November 4 to December 16, EURUSD only managed to recover by +0.28%.
Even as the holidays descending upon markets, with inflation expectations still falling (the 5Y5Y breakeven inflation rate closed the week at 1.366%, just off the yearly low set on December 17 at 1.298%), the ECB’s doves will only feel emboldened to bring forth a new easing program at the January 22 meeting. The next few weeks may be dicey with diminished liquidity conditions, but the stars are aligning for a rough start to 2015 for the Euro. –CV
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Japanese Yen May Resume Recovery on Year-End Capital Flows
Fundamental Forecast for Japanese Yen: Bullish
Static Domestic Landscape Puts External Factors in Charge of the Yen
Year-End Flows May Drive Yen Recovery Amid Carry Trade Liquidation
Help Identify Critical Japanese Yen Turning Points with DailyFX SSI
The outcome of Japan’s snap election passed without making much noise in the financial markets last week as expected. The LDP sailed to an easy victory and secured the super-majority it needed to ensure the continuity of “Abenomics”, at least through the near to medium term.
With the last Bank of Japan policy meeting of the year also behind them, investors have been left with external forces as the foremost driver of Japanese Yen price action. Seasonal capital flows stand out as the most potent potential driver on this front and may drive the unit higher in the final weeks of 2014.
Swelling risk appetite – embodied by a relentless push upward by US share prices – was a defining feature of the macro landscape over the past year. This seemed to reflect a response to Fed monetary policy: the steady QE tapering process defined a clear window in which policymakers would not withdraw stimulus.
The landscape probably won’t look as rosy in 2015. While the precise timing of liftoff for the Fed policy rate is a matter of debate, the commencement of stimulus withdrawal at some point in the year ahead seems to be a given. The prospect of higher borrowing costs may fuel liquidation of exposure reliant on cheap QE-based funding as market participants lock in year-end performance ahead of tougher times ahead.
For currency markets, such a scenario may take the form of an exodus from carry trades, which are usually funded in terms of the perennially low-yielding Japanese unit. That would imply a wave of covering on short-Yen positions, pushing prices higher.
GBP/USD Range in Focus Ahead of U.K. & U.S. 3Q GDP Reports
Fundamental Forecast for Pound:Bullish
The British Pound traded higher versus all G10 counterparts save the US Dollar and Japanese Yen. Why might it continue higher through the foreseeable future?
There’s relatively little in the way of foreseeable economic event risk out of the UK next week, and that may in fact play in the domestic currency’s favor. It was only two weeks ago when GBP/USD volatility prices traded to multi-year peaks, and a negative correlation between vols and the GBP helped explain why it fell sharply on clear uncertainty. Yet in a remarkable shift in sentiment, the Sterling now boasts the lowest volatility prices of any G10 currency. If correlations hold firm, this may be enough of a reason for continued appreciation.
A key exception comes from final revisions to Q2 Gross Domestic Product growth numbers due Tuesday, but surprises are relatively unlikely and only a big miss would force important GBP volatility. Beyond that, traders will keep an eye on the usual slew of early-month US economic event risk—especially the end-of-week US Nonfarm Payrolls report.
With the Scottish Independence Referendum now past, the UK currency can return to basics and trade off of traditional fundamental factors. Credit Suisse Overnight Index Swaps show that the Bank of England will raise benchmark interest rates by approximately 0.50 percentage points in the coming 12 months. This may not seem like much, but it is only second to the US Federal Reserve (and US Dollar) at +0.58%.
The clear divergence in growth and yield expectations between the UK and other major economies leaves the GBP in the position of strength. And though an obvious US Dollar uptrend makes us reluctant to buy into GBPUSD weakness, we believe the UK currency could trade higher through the coming week and perhaps month.
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
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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.