Forecasts

FOMC Set to Start Quantitative Tightening - How Will Bonds, USD Respond?

Price action and Macro.

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FOMC Set to Start Quantitative Tightening - How Will Bonds, USD Respond?

Talking Points:

Fundamental Forecast for USD: Neutral

The big U.S. data point for this week was Thursday’s release of inflation for the month of August. And while this came-out in a rather encouraging format, with headline printing at 1.9% versus an expectation of 1.8% while core came-in at 1.7% versus the 1.5% estimate, bulls were unable to hold on to the previous week’s gains as sellers took over ahead of a pivotal Federal Reserve meeting next week. This better-than-expected inflation print is the second consecutive month of higher prices for the U.S. economy; and this comes after a troubling turn in the beginning of the year that saw inflation swan-dive from a 2.7% high in February down to a low of 1.6% in June. Normally – a print such as we saw yesterday would bring at least a day’s worth of strength into the Dollar; but the context with which we are currently operating can’t quite be considered normal as a huge FOMC meeting looms on the docket for next week, when the bank may announce the start of Quantitative Tightening.

U.S. Inflation Increases for Second Consecutive Month in August

FOMC Set to Start Quantitative Tightening - How Will Bonds, USD Respond?

Chart prepared by James Stanley

Wednesday brings a pivotal rate decision from the Federal Reserve in which the bank is expected to be the first major Central Bank to start Quantitative Tightening. During the Great Financial Collapse and recovery, the Federal Reserve’s Balance Sheet ballooned to $4.5 Trillion. And while this was a highly unusual or an ‘extraordinary’ level of accommodation, buying bonds in the open market and flushing the banks that sold those bonds with cash, it accomplished the Federal Reserve’s goal of quelling the sell-off during the Financial Collapse and keeping markets from plummeting in the immediate period thereafter. But it’s too early to call this mission accomplished as of yet, because now it’s time to put QE in reverse with QT (Quantitative Tightening, or the opposite of QE), and nobody really knows how markets will respond as we’ve never seen anything like it.

In May of 2013, the Fed first announced that they would begin to taper their $70 billion-per-month bond buying program, and fixed income markets convulsed in a situation that eventually became known as the taper tantrum. After numerous assurances from various Fed officials that any changes would be gradual, normalcy was eventually restored until we finally saw the Fed finish their bond purchases in October of 2014. At this point, the Fed had accumulated a $4.48 trillion portfolio largely consisting of treasury and mortgage-backed securities; and since then they’ve been re-investing coupon and principal payments as part of their open market operations. This has kept the heavy hand of the Federal Reserve as an active participant in two key areas of the bond market; and that heavy hand and the demand that it carries has helped to keep interest rates in the United States low.

The Fed is not taking QT lightly: They’ve previously announced that they weren’t going to invoke direct bond sales, and they were simply going to let maturing bonds ‘run-off’ of the balance sheet by not reinvesting coupons and principal payments by a set amount each month. This is going to start with $6 billion per-month in Treasuries and $4 billion per month in mortgage-backed securities, increasing by that same amount each month until the Fed is letting $30 billion-per month roll-off in Treasuries and $20 billion-per-month in mortgage-backed securities. For how long will this last? We don’t know that part yet, as the Fed hasn’t yet mentioned an ultimate target for the size of the balance sheet. We simply know that the Fed wants to tip their toe into the water to see if bond markets convulse in the way that they did in 2013/2014 as the biggest market player in the land starts to become less-long of one of the most important assets in the world.

The goal for Janet Yellen is stability. She’s previously said that balance sheet reduction will ‘run quietly in the background.’ The Fed also envisions being able to institute a dual-tightening mandate, whereby they’re not only letting the balance sheet diminish by not reinvesting bond proceeds, but also by continuing to hike rates in the effort of further normalizing policy. Markets don’t appear to be buying that thesis. The Fed first started talking about balance sheet reduction around their March rate decision, and since the week of that rate hike, the U.S. Dollar has been obliterated as sellers have taken-out more than -10.5% of the value in ‘DXY’. This sell-off has deepened even though the Fed continues to say that they want to hike rates four times going out to the end of next year, and even when they were one of the few major Central banks to hike rates in Q2.

U.S. Dollar via ‘DXY’ Daily: -12.3% Drawdown This Year, -10.5% Since March 14

FOMC Set to Start Quantitative Tightening - How Will Bonds, USD Respond?

Chart prepared by James Stanley

This bearish price action in the U.S. Dollar that’s shown up since that March rate hike appears to be clear evidence that markets are skeptical of the Fed being able to continue hiking rates while also tightening the money supply via balance sheet reduction. Given that balance sheet run-off is going to increase each month until we hit a target of around $50 billion/month, this is going to function as an increasing form of pressure on the money supply. Sure, the first $10 billion might not change matters much, but as bond traders and market participants prepare for the steadily increased amount of bonds that are going to be filtering into the marketplace via the Fed’s lessened demand, matters can change considerably, and this presents a very opaque backdrop for the U.S. Dollar in the near-term.

The forecast for the U.S. Dollar will be set at neutral for next week until more information can be had around how the Federal Reserve will begin the process of Quantitative Tightening and, perhaps more importantly, how markets are going to respond.

--- Written by James Stanley, Strategist for DailyFX.com

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Euro Turns to CPI, PMI Data Ahead of German Elections

News events, market reactions, and macro trends.

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Euro Turns to CPI, PMI Data Ahead of German Elections

Fundamental Forecast for EUR/USD: Neutral

- The final August Euro-Zone CPI reading on Monday should show a modest increase from the preliminary reading, in line with what have been rising medium-term inflation expectations.

- German elections next weekend pose little risk to the Euro as German Chancellor Angela Merkel is expected to win another term with relative ease.

- According to the CFTC’s latest COT report, net-long Euro positions among speculators fell by over -10% through the week ended September 12.

The Euro gained ground against the Japanese Yen and the Swiss Franc last week, but that was it; all of the other major currencies gained ground versus the Euro. By the looks of it, even though there are several notable events due out on the calendar ahead, the Euro may not be in the driver’s seat of its own destiny.

Even though the European Central Bank sent strong signals that it would be announcing a taper to its QE program just days earlier at their September policy meeting, it seems that market participants have fully priced this eventuality into the Euro, and have started to take profit after a multi-month rally: with no new bullish catalyst last week, speculators cut their net-long Euro positions

Generally, however, fundamental drivers for the Euro appear to be moving in the right directionhelping keep traders in a ‘buy-the-dip’ mindset with regards to the Euro. Euro-Zone economic data has been modestly outperforming expectations, as measured by the Citi Economic Surprise Index. The Euro-Zone CESI inched up to +18.4by the end of the week, up from +9.9 a month earlier. We’ll see if this positive data momentum has translated into improvement in growth conditions with the release of the preliminary September Euro-Zone (and individual country) PMIs on Friday.

Elsewhere, the 5-year, 5-year inflation swap forwards, a measure of medium-term inflation (and one of ECB President Draghi’s preferred gauges) closed last week at 1.620%, higher than the 1.591% reading a month ago. This bodes well for incoming inflation data on Monday, which is supposed to show that the final August Euro-Zone CPI reading ticked up to +1.5% from +1.3% (y/y). Given broad Euro strength over the past few months, any signs that inflation is picking up will do great service to ease ECB concerns over reducing its monetary stimulus.

At the tail end of the week, attention for the Euro will shift to the German general election, which has been a non-issue: German Chancellor Angela Merkel, the steward of the Euro during its dark years after the Global Financial Crisis, looks like she will comfortably win. The Catch-22 is that her main political rival in the election, Martin Schulz, is equally if not more pro-European fiscal integration that she is. Either way, the next chancellor of Germany will be someone who isn’t a Eurosceptic.

Accordingly, with the September FOMC meeting this Wednesday, it appears that the Euro is ready to be overshadowed, not due to a lack of important fundamental drivers on its own side, but simply because the outcomes resulting from upcoming events and data on its side appear already priced in.

See our Q3’17 Euro forecast - check out the DailyFX Trading Guides.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher, email him at cvecchio@dailyfx.com

Follow him in the DailyFX Real Time News feed and Twitter at @CVecchioFX.

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Japanese Yen May Lose Out If Fed Keeps A Rate Hike In Focus

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Fundamental Japanese Yen Forecast: Bearish

  • Both the US and Japanese central banks will set policy this week
  • Neither is expected to move the dials, so comment will be key
  • A relatively hawkish Fed could see the Yen head lower

What does the retail foreign exchange community make of the Japanese Yen’s prospects? Take a look at the DailyFX Sentiment Page

The coming week will see monetary policy meetings at both the US Federal Reserve and the Bank of Japan but there are no prizes for guessing which will be more important for Japanese Yen trade. Neither central bank is thought likely to move the policy dials at all, which will leave their commentary at a premium for markets. And here, of course, the Fed will top the bill.

After all the BoJ remains committed to its ultra-loose monetary policy settings until consumer price inflation sustainably tops 2%. It’s currently chugging along at 0.4% so that time can hardly be at hand. Therefore Governor Haruhiko Kuroda can only be expected to underline his ancient status quo once again when he meets the press on Thursday. If he does (when he does?) the markets are unlikely to move much.

Meanwhile, US consumer price inflation is running at seven-month highs and bets on another interest rate increase before New Year’s Eve have consequently increased. Investors will want to know if damage from Hurricanes Irma and Harvey has given Fed hawks any pause but, assuming they get past Wednesday’s policy decision with the idea that hikes are still on the cards, then USD/JPY should at least find support.

Beyond the central bank meetings, the week’s Japanese economic data can probably be discounted as much of a Yen driver. There isn’t much anyway. Sadly the baleful influence of North Korea on global risk appetite can never be so discounted and, should its missiles fly again, then the Yen will probably stand to gain. However, if risk appetite is bolstered by silence from Pyongyang- and a relatively optimistic Fed- then the Japanese currency is likely to lose ground.

Japanese Yen May Lose Out If Fed Keeps A Rate Hike In Focus

--- Written by David Cottle, DailyFX Research

Contact and follow David on Twitter:@DavidCottleFX



GBP: The Central Bank Clears the Path for Rate Hikes

Fundamental analysis and financial markets.

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GBP: The Central Bank Clears the Path for Rate Hikes

Talking Points:

  • GBP/USD hits a 15-month high.
  • Market expectations now point to a 0.25% rate hike in 2017.
  • GBP/USD may test 1.4000 if the FOMC disappoints on Wednesday.

Fundamental Forecast for GBP: Bullish

The bank of England made clear this week that markets are underestimating the possibility of an interest rate hike this year, despite weak GDP and wage growth numbers. The clear message was sent out by governor Carney after Thursday’s MPC meeting and reinforced by a hawkish speech by BOE policy maker Gert Vlieghe, a one-time dove. Cable duly responded hitting a 15-month high and still has room to move to the upside, especially as the USD remains weak.

On the weekly chart the 38.2% retracement of the July 2014 – October 2016 sell-off comes into play at 1.39116 while the a gap up to 1.40175 also remains to be filled, helping to complete a reverse head and shoulders. Support remains at the 23.6% Fibonacci retracement at 1.31379, while the August 3 high of 1.32700 should also provide a layer of downside protection.

Chart: GBP/USD Weekly Time Frame (April 2014 – September 15, 2017)

GBP: The Central Bank Clears the Path for Rate Hikes

Care should be taken at the start and the end of the week with BOE governor Carney speaking to the IMF on Monday while UK PM Theresa May sets out the government’s position on Brexit in a speech in Florence on Friday. And just to keep traders on their toes, the latest FOMC policy decision, summary of economic projections and accompanying press conference are unveiled on Wednesday.

--- Written by Nick Cawley, Analyst

To contact Nick, email him at nicholas.cawley@ig.com

Follow Nick on Twitter @nickcawley1



Gold Price Forecast Hinges on Fed Rate Decision, Policy Outlook

Short term trading and intraday technical levels

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Fundamental Forecast for Gold:Neutral

Gold prices snapped a three week winning streak with the precious metal down 1.72% to trade at 1323 ahead of the New York close on Friday. The losses come alongside a rebound in the USD and Treasury yields despite expectation the FOMC will hold rates next week.

All eyes will be on Janet Yellen & Co next week when the Federal Reserve holds its quarterly interest rate decision on September 20th. Markets will be closely eying the fresh quarterly projections from Fed officials as they pertain to growth, employment and interest rates. In the wake of hurricanes Harvey & Irma, central bank doves may argue to further delay the normalization cycle with the dollar likely to face further headwinds if the committee opts for a shallower path for interest rates.

Gold has been well-supported over the past few months on persistent weakness in the greenback and rising geo-political tensions and that’s not likely to end anytime soon. That said, prices responded to structural resistance this week and although the pullback may have a bit further to go, the broader outlook for bullion remains constructive.

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Gold Price Forecast Hinges on Fed Rate Decision, Policy Outlook
  • A summary of IG Client Sentimentshows traders are net-long Gold - the ratio stands at +2.28 (69.5% of traders are long)- bearish reading
  • Long positions are 12.4% higher than yesterday and 15.8% higher from last week
  • Short positions are 10.8% lower than yesterday and 23.9% lower from last week
  • We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests Spot Gold prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger Spot Gold-bearish contrarian trading bias.

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Gold Daily

Gold Price Forecast Hinges on Fed Rate Decision, Policy Outlook

Last week we highlighted that, “While the rally in gold has been quite impressive, prices are now approaching some longer-term objectives and even though the broader focus remains constructive, heading into next week the risk remains for some corrective price action before heading higher.” Indeed gold reversed off confluence resistance this week with the pullback now testing support at 1321/25 into the close of the week. Note that prices have now set a clean monthly opening-range just above basic trendline support and we’ll be looking for a break of this region for further guidance on the near-term outlook.

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Gold 240min

Gold Price Forecast Hinges on Fed Rate Decision, Policy Outlook

Gold Price Forecast Hinges on Fed Rate Decision, Policy Outlook

A closer look at price action highlights the potential for a bull-flag formation here. Watch for support next week into the monthly opening-range low / lower parallel at 1316 with a breach of this near-term descending channel targeting 1355 & the 2016 high-close at 1366. A more significant Fibonacci consideration is eyed just higher at1377/79. A close below 1295/99 would be needed to suggest a more meaningful correction is underway.

Bottom line: prices need to stabilize at these levels if the broader uptrend off the July lows is to remain viable. Look for a definitive break of the monthly opening range heading into the Fed next week.

---Written by Michael Boutros, Currency Strategist with DailyFX

Follow Michaelon Twitter @MBForex contact him at mboutros@dailyfx.com or Click Here to be added to his email distribution list.



CAD Rally: Too Much, Too Soon?

Fundamental analysis and financial markets.

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CAD Rally: Too Much, Too Soon?

Talking Points:

  • USD/CAD falls to lows seen in May 2015 on Rate Hike
  • Further hikes are being mooted but will the BoC wait?
  • USD weakness is exacerbating the move.

Fundamental Forecast for CAD: Neutral

We remain neutral on CAD although any further sharp upward moves may open the opportunity to sell CAD against the USD for a short-term reversal. USD/CAD has fallen 12% in the last four months – from 1.3790 to 1.21350 – while the USD Dollar Basket has fallen 7.6% over the same timeframe.

The Bank of Canada (BoC) has hiked rates by 0.25% at both of the last two policy meeting (July and September) leaving commentators divided over the timing of the next move. Commentating on this week’s hike, the central bank noted that recent economic data had been ‘stronger than expected’ supporting the bank’s view that growth in Canada is becoming ‘more broadly-based and self-sustaining’. However the governing council also noted that there was some excess capacity in Canada’s labour market, while given elevated household indebtedness, ‘close attention will be paid to the sensitivity of the economy to higher interest rates’.

The next meeting on October 25 also coincides with the latest quarterly Monetary Policy Report where BoC governor Stephen Poloz will give updated guidance on the economy, including inflation projections.

Looking at the weekly USD/CAD chart the strength of the Loonie can be clearly seen, but the last sharp downturn after this this week’s hike has left a ‘gap’ that needs filling back to 1.23380 before the Loonie can appreciate further. Further upside resistance comes in the form of July’s old ‘triple-bottom’ at 1.24120 while the May 2015 low at 1.19190 is the first target for CAD bulls.

Chart: USD/CAD Daily Time Frame (May – September 8, 2017)

CAD Rally: Too Much, Too Soon?

Chart by IG

And you can check out our latest Q3 trading forecast for the Canadian Dollar here.

--- Written by Nick Cawley, Analyst

To contact Nick, email him at nicholas.cawley@ig.com

Follow Nick on Twitter @nickcawley1



Australian Dollar Looks Stuck, Albeit Close to New Highs

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Fundamental Australian Dollar Forecast: Neutral

  • The Australian Dollar remains quite close to its new, 2017 highs
  • The Reserve Bank of Australia may not like that, but seems to accept that there’s little it can do
  • An as expected Fed policy meet won’t change the AUD/USD outlook

Just getting started in the AUD/USD trading world? Our beginners’ guide is here to help

The coming week doesn’t look as though it’s going to be a game changer for the Australian Dollar, at least against its US counterpart.

Yes, of course, there is a Federal Reserve monetary policy meeting on Wednesday and trading action may be a little sparse in the runup. But if the US central bank does as it’s expected to - leave interest rates alone but reserve the right to raise them again this year if the economy and inflation hold up- then AUD/USD traders will be little wiser after the meeting than they were before.

That pair is sitting pretty close to new highs for the year, highs which have come despite a long chorus of Reserve Bank of Australia luminaries worrying aloud about the negative effects of a strong currency on the economy in their charge. Now it seems that the RBA has concluded that this trend isn’t worth fighting with anything other than rhetoric, that their currency remains attractive even with domestic interest rates at record lows and that there isn’t much to be done about it, negative effects and all.

Investors will hear from RBA Governor Philip Wheeler and Assistant Governor Luci Ellis this week. If they hammer currency strength anew then AUD/USD buyers may be deterred. But recent history suggests that such jawboning doesn’t hit AUD for very long. They might ramp up the volume of course, but that doesn’t seem especially likely.

Australian data is quite sparse this week and in any case unlikely to drive the memory of last week’s strong employment report from investors’ minds. All in all, it looks as though it just has to be a neutral call for the Aussie, so it is, with the proviso that no news comes from North Korea’s direction to sap the markets of risk appetite generally and appetite for the Aussie in particular.

Australian Dollar Looks Stuck, Albeit Close to New Highs

--- Written by David Cottle, DailyFX Research

Contact and follow David on Twitter: @DavidCottleFX



NZD Boosted by Risk-on Sentiment But Weakness Remains

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NZD Boosted by Risk-on Sentiment But Weakness Remains

Talking Points:

  • The RBNZ will be closely watching the recent Kiwi uptick.
  • The latest quarterly producer price data was mixed.
  • The downside still looks the path of least resistance for NZD/USD.

Fundamental Forecast for NZD: Neutral

We remain neutral on the New Zealand - with a bias to sell any strong rallies – despite the Kiwi gaining on the back of improving market sentiment. The high yielding currency normally benefits when markets turn ‘risk-on’ and the recent easing of tensions between the US and North Korea saw NZD buyers return. The RBNZ however will be watching the currency closely and has in the past said that it would act if needed to contain any unwanted currency appreciation.

The latest PPI figures showed a mixed message with input costs rising by 1.4%, compared to last quarter’s 0.8%, while output costs rose by 1.3% against a prior quarter’s 1.4%.

A look at the chart below shows the NZD/USD forming a head and shoulders pattern which normally points to the market turning lower. Resistance is likely to be found around the 0.7360 level ahead of the 23.6% Fibonacci retracement level at 0.7383.

NZD Boosted by Risk-on Sentiment But Weakness Remains

Retail trader data shows a ratio of traders short to long at 2.04 to 1. In fact, traders have remained net-short since May 24 when NZDUSD traded near 0.68435; price has moved 7.0% higher since then. We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests NZD/USD prices may continue to rise. Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed NZD/USD trading bias and leaves us on the side-lines for now.

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--- Written by Nick Cawley, Analyst

To contact Nick, email him at nicholas.cawley@ig.com

Follow Nick on Twitter @nickcawley1



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