Dollar May Not Have a Quiet Thanksgiving...
Fundamental Forecast for Dollar:Bullish
Debate over the timing and pace of the Fed’s normalization path is holding the Dollar back
Yet, a view that hikes will come ‘eventually’ is still a dramatic contrast to counterparts aggressively easing
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From a fundamental perspective, the Dollar’s interest rate backdrop seems to be mired in debate over the timing of the inevitable first hike. Technically, many of its pairings have extended to multi-month or multi-year highs with large boundaries looming just ahead. And, perhaps most condemning for momentum is the ‘market conditions’ consideration of a seasonal liquidity drain for the financial markets for the US-based Thanksgiving holiday. Despite all of these factors, however, the Greenback is more likely to extend its stretch of volatility – and perhaps even extend its drive – as the market appreciates its ‘relative’ appeal.
In a vacuum, the Dollar’s fundamental bearings have grown mixed as of late. Employment figures still show improvement on payrolls, but wages and participant are struggling to catch traction. Sentiment indicators are leveling off after broadly climbing to multi-year highs. Housing data is starting to tremble and manufacturing readings have slipped. A tempered pace of growth would be a concern if it weren’t for the reality that the United States’ peers are in far more troubled circumstances.
Nowhere is the disparity in performance playing to the Greenback’s favor more than with monetary policy. Cooler global winds, the FOMC’s softer tone on perceived inflation threats and a thinly disguised desire not to upset financial markets has kept Fed from solidifying near-term rate forecasts. The markets are certainly unsure about the path of rates as Eurodollar and Fed Funds futures (used to hedge interest rates) project the first hike around September or October of next year. The pace thereafter is seen as very conservative. Yet, the September FOMC forecasts still stand – the central bank made an effort to say its view was unaffected by the October market correction, unlike investors’ view – and the Primary Dealers survey conducted by the New York Fed both maintain a mid-2015 or June move is still most likely.
As vague as the Fed’s hawkish path is, it is nevertheless ‘hawkish’. That contrasts dramatically from its major counterparts. The Bank of Japan has upgraded its open stimulus program back in October, while the 3Q recession and expected delayed tax hike add to forecasts. China offered up an unexpected upgrade of its own with the first interest rate cut in two years. And, the European Central Bank is on a path of steadily growing accommodation with a full-blow, government bond-centered program seeming not far away. These are the United States’ largest economic counterparts and their respective currencies the Dollar’s most liquid foils. Their descent indirectly lifts the US currency.
The influence that this relative monetary policy perspective (along with its growth, return and other fundamental implications) has over the Forex market – much less the Dollar – can keep the volatility fires burning for the asset class through the coming week. That is remarkable as the US-based Thanksgiving holiday period often breaks the transmission of risk trends and quiets the capital markets. With the persistent turmoil and pace of policy changes from the rest of the world, the financial system may override the seasonality effect of Thanksgiving. And, even if traditional assets like equities settle; the FX market is far more responsive to ‘mon pol’.
As our attention is set on the most productive fundamental theme (rate / stimulus forecasts) though, we must not write off the threat that an ill-turn in ‘risk’ poses. Given the state of leverage, participation, portfolio balances and asset prices; sentiment can be extremely mercurial. Should confidence bend, we are in for a far deeper well of market adjustment will follow…with heavy Dollar gains.
Latest Promise of Easing from ECB Keeps Euro Rebound at Bay
Fundamental Forecast for Euro:Neutral
- Both EURGBP and EURUSD failed at important resistance this week, keeping the downtrends intact.
- ECB President Draghi’s dovish comments on Friday tipped the scales for the bears.
- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.
EURUSD fell back below $1.2400 by close last week after -1.08% swoon, as surprisingly dovish commentary from the European Central Bank president on Friday provoked the latest downdraft across the EUR-spectrum. The 18-member currency lost ground against all but two of the other seven major currencies, with minimal gains coming against the continually weak Japanese Yen (EURJPY +0.21% to ¥145.96) and the Swiss Franc (EURCHF +0.02% to Sf1.2016).
ECB President Mario Draghi’s comments in Frankfurt, Germany on Friday add fuel to the speculative fire that the ECB will unveil new stimulus measures at its December 4 meeting, at which time new ECB staff projections will be unveiled as well. President Draghi said that “We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires,” and that inflation expectations “have been declining to levels that I would deem excessively low.”
A look at the 5Y5Y breakeven inflation swaps, President Draghi’s preferred market measure of medium-term inflation expectations, fell to a new closing low for the year on Friday at 1.567%; one week earlier inflation expectations were only marginally higher at 1.602%.
As discussed in the November 2 iteration of this article, “Once the recent measures pass through the market over the course of November, if the 5Y5Y swap rates don’t pick back up, the prospect for easing at the December policy meeting will have increased.” It seems we’ve crossed the threshold for more action.
In the lead up to the last ECB meeting, there was much speculation over the potential for new easing measures as well; but in lieu of the private infighting over President Draghi’s governing style and ensuing public affirmation of President Draghi’s policy stance, we’re led to believe that any commentary coming from the head of the ECB is genuinely indicative of the direction the central bank is moving, rather than just the opinion of one voting member.
The recent slip in Euro-Zone economic data momentum takes away what was one of the only weapons hawks brought to the ECB: that the recent stimulus measures (rates into negative territory, ABS-program initiation, and TLTROs) were doing enough in the short-term to justify the ECB holding out on new easing. After climbing as high as -15.0 on November 19, the Citi Economic Surprise Index dropped to -36.0 by the end of the week, highlighting how any improved Euro-Zone data is quickly moving into the background.
The prospect of further stimulus remains enough to keep Euro bulls at bay. If anything, Euro rallies are likely to be of the short covering variety, as non-commercials/speculators hold their net-shorts at 168.7K contracts. It’s also worth noting that the market is less saturated with shorts than earlier this year (179.0K contracts for the week ended November 4) or than it was in 2012 during the height of the Euro-Zone crisis (214.4K contracts for the week ended June 5). Positioning reveals that it’s possible we see a further buildup of short positions before a major low in EURUSD is established. –CV
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Yen Looks Past Japan Recession and Election Risk, Sentiment Trends Key
Fundamental Forecast for Japanese Yen: Bullish
Japanese Recession, General Election May Yield Victories for “Abenomics”
Yen May Rise as Firming US Data, Year-End Flows Weigh on Risk Appetite
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The markets responded with relative indifference to what might’ve been expected to be volatility-inspiring news-flow out of Japan last week. Third-quarter GDP figures showed the economy sank back into recession. This triggered Prime Minister Shinzo Abe to dissolve the lower house of the Diet and call a snap election for mid-December to win a mandate for delaying next year’s sales tax increase.
The Yen largely acted as if nothing happened, with prices continuing to drift higher against the US Dollar at the same measured pace seen over the last three weeks. For its part, Japan’s benchmark Nikkei 225 stock index oscillated in a narrow range having set a seven-year high.
Such complacency seems to reflect a market that was amply primed for what was to transpire. Indeed, data from Bloomberg shows media mentions of a possible sales-tax hike delay began to build as early as three weeks ago. Furthermore, investors seem rather sanguine about the whole ordeal.
This seems to make sense. Doubling the sales tax from 5 to 10 percent was a central policy fixture of the DPJ administration of Yoshihiko Noda, Mr. Abe’s predecessor. The Prime Minister shrewdly allowed the first phase of the increase – from 5 to 8 percent – to take effect this year. He probably figured that he could claim a deficit-fighting victory if the economy took the move in stride or score a win against the DPJ if it didn’t.
The latter seems to be playing out and Abe has dutifully called an election in response. His aim is surely to use the onset of recession to trash the DPJ’s economic stewardship and secure a broader grip on power. Given the distinctly expansionary nature of “Abenomics”, it seems hardly surprising that the markets are not perturbed by the prospect of giving the current administration a freer reign.
External factors may disturb the calm however. US economic data began to gather upward momentum relative to consensus forecasts once again last week. More of the same as consumer confidence, home sales, and durable goods orders figures cross the wires in the days ahead might fuel speculation that the Fed will move sooner to deliver its first post-QE3 interest rate hike. That may set off risk aversion, pushing the Yen higher amid liquidation of carry trades funded in terms of the perennially low-yielding currency.
Seasonal forces may amplify this dynamic. While risk appetite flourished in 2014, the generally accepted expectation of on-coming Fed stimulus withdrawal surely casts doubt on more of the same next year in the minds of investors. That may fuel a desire to book profits on risk-sensitive exposure as the year-end holiday cycle gets underway, securing yearly performance numbers ahead of what might be tougher times ahead.
GBP/USD to Break Out on Less-Dovish BoE, Weak U.S. 3Q GDP
Fundamental Forecast for Pound:Neutral
GBP/USD may face a more meaningful rebound in the week ahead as the Bank of England (BoE) highlights the risk of overshooting the 2% target for inflation, while the Federal Reserve remains reluctant to move away from its zero-interest rate policy (ZIRP).
With the BoE scheduled to testify in front of the Parliament’s Treasury Select Committee next week, the fresh batch of central bank rhetoric may heighten the appeal of the British Pound should Governor Mark Carney continue to prepare U.K. households and businesses for higher borrowing costs. Even though the BoE Minutes showed another 7-2 spit at the November 6 meeting, it appears as though there’s a greater dissent within the Monetary Policy Committee (MPC) as the faster-than-expected erosion of economic slack raises the risk for above-target inflation. In turn, we may see a growing number of BoE officials scale back their dovish tone for monetary policy, while the Fed may further delay its normalization cycle amid the subdued outlook for U.S. inflation.
The preliminary 3Q U.S. Gross Domestic Product (GDP) report may serve as another fundamental catalyst to drive GBP/USD higher as market participants anticipate a downward revision in the growth rate, while the core Personal Consumption Expenditure, the Fed’s preferred gauge for inflation, is expected to grow an annualized 1.4% after expanding 2.0% during the three-months through June. As a result, central bank Chair Janet Yellen may largely endorse a more neutral tone for monetary policy going into the end of the year, and 2015 rotation for the Federal Open Market Committee (FOMC) may further dampen the appeal of the U.S. dollar as central bank hawks Richard Fisher and Charles Plosser lose their vote.
With that said, GBP/USD may make a larger attempt to break out of the narrow range on the back of hawkish BoE commentary along with a series of dismal U.S. data, and we would also like to see a topside break in the Relative Strength Index (RSI) as the oscillator retains the downward momentum carried over from the previous month.
Will EUR/CHF Floor Break? November 30 Referendum in Focus
Fundamental Forecast for Swiss Franc: Neutral
- November 30 SNB referendum looms large as EURCHF nears Sf1.2000 floor.
- EURCHF 20-day ATR only 14-pips.
- Have a bullish (or bearish) bias on the Swiss Franc, but don’t know which pair to use? Use a Swiss Franc currency basket.
The Euro-Zone financial crisis and its resulting toll on monetary policy weren’t limited to the European Central Bank: the Swiss National Bank has been forced to act in tandem with the ECB since levying the Sf1.2000 floor on September 6, 2011.
Despite the ECB’s measures over recent months, continued weakness in the European single currency amid sustained disinflationary pressures has helped drive EURCHF lower into the end of 2014. We may however be on the verge of a paradigm shift if those underpinning the gold initiative garner a victory.
As the exchange rate creeps towards the Sf1.2000 floor, on November 30, Swiss residents will vote on a referendum that could force the SNB to increase its foreign reserve allocation to gold, up to 20% from the 8% level it currently resides at. Such a policy could prohibit the SNB from realizing their monetary policy mandate.
With interest rates now near zero, maintaining the floor has become the key to avoiding tightened monetary policy. Vowing to “enforce the minimum exchange rate with the utmost determination” the SNB has been purchasing euros against Swiss francs and is prepared to continue purchasing FX in unlimited quantities. So just how is the SNB maintaining the floor?
Although unconfirmed, they are likely to be selling FX options to keep volatility down in EURCHF as an additional way to manage the floor. Selling volatility also means that the SNB has forced the EURCHF option market to turn long gamma; the hedging activity of options dealers in theory would put a lid on so that the hedging of option dealers would help dampen the daily moves in the pair. This has worked even as EURCHF has approached the floor: the 20-day ATR has fallen from 24-pips on October 15 to 14-pips at close this week.
The big question is: what happens if there is a ‘yes’ vote? Even if the SNB is forced to reallocate its reserve portfolio, the transition is expected to take place over the course of 5-years, so the impact on the floor won’t be immediate – any action around the floor breaking right now is pure speculation and not due to the impending change in policy.
Secondly, even in the event of a ‘yes’ vote, the SNB wouldn’t necessarily need to just sell off its foreign reserves (most of which are euros) to shift the allocation; in an effort to maintain the floor, they could use the proceeds of their QE program instead to facilitate the slow transition, as Credit Agricole notes. The SNB will not simply reduce the size of its balance sheet, especially as the ECB moves into more aggressive easing policies.
If a vote of ‘no’ is upheld few additional options remain available to the SNB in their quest to preserve the minimum exchange rate. The market could see a continuation of the SNB adding euros to foreign reserves via the printing of additional Swiss francs. A cut in the interest rate into negative territory could also be witnessed, as the bank seeks to make investing in the Swiss currency less attractive.
A ‘no’ vote however, does not guarantee a massive covering rally—the market is already long. Very long, actually: the retail crowd is holding long EURCHF positions at a ratio of over 50:1 per the most recent SSI update. While the Swiss National Bank firmly stands on this side of the referendum, the outcome and resulting policy changes remains uncertain.
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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.
AUD To Look Past Local Data Yet Remains At Risk On Elevated Volatility
Fundamental Forecast for Australian Dollar: Bearish
AUD/USD Suffers Intraday Volatility Yet Remains Above 2014 Low
Scope For Gains Questionable As Elevated Volatility Caps Carry Demand
Downside Risks Centered On Recent Lows Near The 0.8540 Mark
The Australian Dollar witnessed another week of intraday volatility, yet limited follow-through. Local economic data once again proved uneventful for the currency, amid well-anchored RBA policy bets. Indeed the latest Minutes reiterated the central bank’s preference for a “period of stability” for rates and offered few fresh insights into policy makers thinking.
Looking to the week ahead; local Capital Expenditure and New Home Sales data headline the domestic economic calendar. Rampant speculative lending in the housing market has been a concern for policy makers and has created a reluctance to cut rates further. However, the rather volatile upcoming home sales data is unlikely to materially alter the rate outlook. Similarly, it would likely take a significant surprise to the Capex figures in order to change policy bets. This in turn could continue to leave the Aussie to take its cues from elsewhere.
One of the biggest threats to the currency remains the potential for a further pick-up in implied volatility. Measures like the CVIX are near their peaks for the year suggesting traders are anticipating some large price movements amongst the major currencies. Such an environment generally bodes ill for the high-yielding currencies, who stand to outperform in low-volatility settings.
Meanwhile futures positioning suggests the wave of short-selling has turned into a trickle. Yet it remains off the extremes witnessed last year, suggesting more room may exist in the trade.
Downside risks for AUD/USD are centered on the 2014 lows near 0.8540, which if broken may set the pair up for a run on the July 2010 trough near 0.8320.For insights into the US Dollar side of the equation read the weekly forecast here.
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.