Is This A Dollar Rally or EUR/USD Tumble – It’s Not the Same Thing

Fundamental analysis and market themes.

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Is This A Dollar Rally or EUR/USD Tumble – It’s Not the Same Thing

Fundamental Forecast for Dollar:Neutral

  • Top event risk for the week ahead is the 3Q US GDP figures which could indeed alter December rate forecasts
  • With the exception of EUR/USD and USD/CAD, the Dollar was either little changed or lower against the majors last week

The ICE Dollar Index (DXY) posted another impressive week’s advance through this past Friday. That marks three consecutive weeks that the benchmark currency has climbed to eight-month highs – and at the fastest pace since the November rally back to 12-year highs. Given this performance, traders are left to wonder if the Greenback has changed gears and returned to the bull trend that was waylaid nearly 18-months ago. There are certainly go-to fundamental rationalizations for those looking to jump on the momentum: the Fed is promising a hike in the foreseeable future; ominous clouds over risk trends necessitate a safe haven; and faltering commodity trend will indirectly bolster the primary pricing instrument. Yet, these are overreaching for convenience. Congestion is a more universal condition, and the Dollar’s performance is far from uniform.

When taking measurements, it is important to understand your tools and their calibrations. For those referencing the DXY, its performance does look impressive. Yet, there is a distinct concentration to this barometer that provides a skew to the signal. The ICE index is trade-weighted, which given heavy weighting to EUR/USD (the most liquid exchange rate in the FX market by a wide margin). This benchmark pair dropped 2.8 percent over the past two weeks – the biggest Dollar move amongst the majors – to a 7-month low. The other ‘majors’ were bound to their ranges. That would suggest the Dollar could take limited credit for this progress.

Technically speaking, the Greenback could capably rally forever should its major counterparts consistently lose ground. However, that is unlikely in a market defined by congestion and uneasy complacency. From the Euro, lost ground after the ECB’s decision to defer its taper announcement doesn’t write the script for a full topple for the currency. Pound has shown greater resilience to Brexit headlines this past week. Yen and commodity-based crosses meanwhile are waiting for their cues from risk benchmarks. This is not a cast of characters that seem likely to put the Dollar in the spotlight.

Looking out over the coming week’s docket, however, there is reason to believe the Greenback may be able to rest back control of its own bearings. Monetary policy is generally the most productive theme for the FX market these past years, so it is reasonable to presume that it would offer the most ready traction should it look for grip. Speculation is not focused on the November 2nd meeting (due in part to its proximity to the US Presidential Election and the uncertainty that event presents) but rather the December 14th ‘anniversary’ to the first the first hike. Fed Fund futures price approximately a 66 percent probability that the central bank moves at that meeting.

To bolster the conviction of a 12-month follow up to ‘liftoff’, the most capable event to move the needle is the US 3Q GDP update. This is the kind of systemic assessment of the economic picture that can be considered black-and-white in defining the conditions for monetary policy. A significant rebound from the second quarter’s moderate 1.4 percent pace could solidify hike motivation. Indeed, the consensus forecast is for a pickup to a 2.5 percent pace of expansion. Yet, it should be said that such a forecast sets the bar high. Further, this key event is due at the very end of the week.

Other fundamental fodder to move the rate view and/or the Dollar include a host of Fed speeches penciled in. The terms of this policy group’s tone is changing with remarks like those made by San Francisco Fed President John Williams who said they should have hiked in September and low rates can lead to a recession. Another indicator to keep tabs on is the Conference Board’s consumer sentiment survey. Both the headline and components are valuable forecasting for economic activity moving forward.

Euro Weakness Unleashed as Draghi Dismisses Immediate Taper Concerns

News events, market reactions, and macro trends.

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Euro Weakness Unleashed as Draghi Dismisses Immediate Taper Concerns

Fundamental Forecast for Euro: Neutral

- ECB President Draghi dispatched speculation of an immediate tapering of QE.

- Traders forced to ‘kick the can’ down the road until December.

- Have a bullish (or bearish) bias on the Euro, but don’t know which pair to use? Use a Euro currency basket.

The Euro took another leg lower this week, sliding deeper in its losing streak as markets were forced to deal with reality: the European Central Bank would not be tapering its QE program immediately. EUR/CAD was the only EUR-cross above water this week (+0.65%), with EUR/JPY (-1.18%) and EUR/NZD (-1.86%) leading the way to the downside as a result.

Mincing no words: it was clear markets were mispricing the ECB rate decision on Thursday. The highly sensitive nature of the Euro to the simple absence of information about the future path of the ECB‘s easing – and then President Draghi’s forceful, ‘we haven’t discussed anything’ approach – is evidence of this mispricing. Either way, what is clear is that Thursday’s ECB meeting was a lesson in ‘Kicking the Can Down the Road 101’: Draghi & co. absolved themselves of any responsibility until the committees tasked with “ensuring the smooth implementation” of the QE programs returns with their notes at the December meeting.

“Ensuring smooth implementation,” in context of the ECB’s desire to maintain its QE program until the medium-term inflation target of +2% is reached, is to prevent collateral scarcity issues from cropping up and perhaps leading to a European ‘taper tantrum.’ Given how far away inflation reality is from the ECB’s target, it would seem that “ensuring smooth implementation” means the ECB is not concerned with upping the size of the QE program.

What will likely happen: at an upcoming meeting, the ECB will indicate that it needs to adjust the way its bond buying program is conducted. The ECB allots its bond buying based on the capital key. What is the capital key? The capital of the ECB comes from the national central banks (NCBs) of all EU member states. According to the ECB, the NCBs’ shares in this capital are calculated using a key which reflects the respective country’s share in the total population and gross domestic product of the EU.

As such, it's no surprise that Germany - as the country with the largest capital key contribution - has seen the belly of its yield curve (3Y-7Y) drift lower into negative territory, below the ECB's -0.40% deposit level - the threshold at which the ECB no longer purchases bonds in its QE program. Likewise, the ECB needs to either: remove the limiting parameter of -0.40% on its bond buying; or discard the capital key variable. In the first case, German yields would like move lower the fastest; in the second, peripheral yields like in Italy and in Spain.

Further, when these changes to the QE program are made, it is likely that an extension of the program is announced, perhaps with some tapering built in. For example, markets had been pricing the QE program to run through the end of March 2017 (roughly €400 billion in asset purchases remaining), but a six month extension even at a slower pace of purchases (say, to €55 billion per month for three month and €20 billion per month for three months) would still amount to a significant increase in easing (roughly an additional €225 billion in asset purchases) above prior expectations. –CV

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Bank of Japan and US Federal Reserve Keep USD/JPY Downtrend Intact

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Bank of Japan and US Federal Reserve Keep USD/JPY Downtrend Intact

Fundamental Forecast for the Japanese Yen: Neutral

The Japanese Yen rallied for the third-consecutive week versus the US Dollar on a key disappointment from the US Federal Reserve and relative inaction from the Bank of Japan. The week ahead promises substantially less foreseeable event risk, and the USD/JPY may continue its broader trend lower absent material surprises out of a handful of US and Japanese economic data releases.

What should have been a critical 12 hours for the Dollar/Yen exchange rate proved fairly uneventful as the US Federal Reserve kept rates unchanged and the Bank of Japan made few changes to existing monetary policy. Traders continue to believe the US Federal Reserve will raise rates at its December meeting, but there is very little reason to expect fresh policy action out of Bank of Japan. And indeed underwhelming policy from the BoJ will likely work in the Japanese Yen’s favor (against the USD/JPY) given previous expectations of an expansion in the bank’s Qualitative and Quantitative Easing (QQE) policy.

Bank of Japan Governor Haruhiko Kuroda announced two notable changes—officials will target inflation above their previous target of 2.0 percent and will establish a floor for the 10-year Japanese Government Bond yield. Pushing their inflation target higher makes little difference when the bank has thus far been unable to achieve their stated 2 percent target. Setting a specific target for the 10-year JGB yield is the more important and arguably controversial move, however; last week we highlighted why they might target the yield curve, and this is clearly their attempt at doing so.

In theory the BoJ has committed itself to limitless bond purchases if it is to maintain a specific target on the 10-year JGB yield. In practice, however, the targeted bond was already trading just barely above the bank’s target. Nothing will change absent a material rally in JGB’s, and traders are effectively left with the status quo.

Japanese Yen traders are likewise left with an effectively unchanged fundamental outlook, and this in itself favors a continued JPY rally (USD/JPY decline) versus the US Dollar. Only a material break above key range highs would shift our near-term trading bias on the USD/JPY. - DR

GBP/USD Range Vulnerable to 3Q GDP Reports, BoE/Fed Rhetoric

Central bank policy, economic indicators, and market events.

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GBP/USD Range Vulnerable to 3Q GDP Reports, BoE/Fed Rhetoric

Fundamental Forecast for GBP: Neutral

The 3Q Gross Domestic Product (GDP) reports coming out of the U.K. and U.S. along with a fresh wave of central bank rhetoric may spur increased volatility in GBP/USD, but the pair may continue to consolidate within a narrow range as British Prime Minister Theresa May increases her efforts to avoid a ‘hard Brexit.’

Bank of England (BoE) Governor Mark Carney is scheduled to appear before the House of Lords Economic Affairs Committee next week as U.K. lawmakers continue to assess the economic implications of leaving the European Union (EU), but the central bank head may largely endorse a wait-and-see approach for monetary policy as a growing number of officials sees a greater threat of overshooting the 2% target for inflation amid the sharp depreciation in the British Pound. With the U.K. economy expected to grow an annualized 2.1% during the three-months through September, the Monetary Policy Committee (MPC) may sound increasingly hawkish and stick to the sidelines throughout the remainder of the year as central bank officials warn the next quarterly inflation due out on November 3 will reflect the sharp decline in the exchange rate. In turn, the bearish sentiment surrounding the sterling may abate ahead of the BoE’s November meeting, but efforts by the new government to prevent a ‘hard Brexit’ may fail to bear fruit as the EU remains reluctant to starting negotiations until Article 50 of the Lisbon Treaty is enacted.

At the same time, economic activity in the U.S. is anticipated to pick up in the third-quarter, with the growth rate projected to increase an annualized 2.5% following the 1.4% expansion during the three-months through June, but a marked slowdown in the core Personal Consumption Expenditure (PCE), the Federal Reserve’s preferred gauge for inflation, may drag on interest-rate expectations as central bank officials continue to warn ‘survey-based measures of longer-run inflation expectations were little changed, on balance, while market-based measures of inflation compensation remained low.’ Even though the Federal Open Market Committee (FOMC) appears to be following a similar path to 2015 and talks up expectations for a December rate-hike, New York Fed President William Dudley, St. Louis Fed President James Bullard, Chicago Fed President Charles Evans, Governor Jerome Powell and Atlanta Fed President Dennis Lockhart may continue to endorse a ‘gradual’ path in normalize monetary policy as the central bank remains cautious in removing the accommodative policy stance. With that said, dovish remarks from the slew of Fed officials may undermine the near-term strength in the greenback especially as the central bank continues to reduce its long-run interest rate forecast in 2016.

GBP/USD Range Vulnerable to 3Q GDP Reports, BoE/Fed Rhetoric

The broader outlook for GBP/USD remains tilted to the downside as it preserves the bearish trend carried over from the previous month, but the range-bound price action following the British Pound ‘flash crash’ may persist ahead of the key U.S./U.K. event risks as market participants weigh the diverging paths for monetary policy. Nevertheless, the recent development in the Relative Strength Index (RSI) suggests a larger recovery could be at hand as the oscillator breaks out of the near-term bearish formation and climbs out of oversold territory, and a break/close above 1.2360 (50% expansion) in the exchange rate may generate a larger correction as the weakness in the pound-dollar appears to be exhausted.

Gold Price Bounce, Rebound in Questions Ahead of US GDP

Short term trading and intraday technical levels

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Gold Price Bounce, Rebound in Questions Ahead of US GDP

Fundamental Forecast for Gold:Bearish

Gold prices were on a firmer footing this week with the precious metal up 1.15% to trade at 1265 ahead of the New York close on Friday. The gains come despite continued strength in the greenback with the USD Index (DXY) rallying back into the 2016 open at 98.69 (highest levels since February). The rebound in bullion is likely to be short-lived however as the technical outlook continues to suggest that further losses are likely before registering a more significant low in price.

Highlighting the economic docket next week is the advanced read on U.S. 3Q GDP with consensus estimates calling for an annualized print of 2.5% q/q. The Core Personal Consumption Expenditure (PCE) will be of particular interest with market expectations calling for a slowdown to 1.6% q/q from 1.8% q/q. Keep in mind that this is the Fed’s preferred gauge of inflation and a softer than expected print could weigh on expectations for a 2016 rate hike. As is stands, Fed Fund Futures are pricing in a 68% likelihood the central bank will hike in December. Look for advances in gold to remain limited as the prospect of higher interest rates weigh on demand for the yellow metal as a store of wealth.

Gold Price Bounce, Rebound in Questions Ahead of US GDP

A summary of the DailyFX Speculative Sentiment Index (SSI) shows traders are net long Gold- the ratio stands at +2.02 (67% of traders are long)- bearish reading. Long positions are 5.4% below levels seen last week while short positions are 30.1% higher over the same time period. The pullback in long exposure softens the strength of the bearish signal and while the broader risk remains lower, the recent dynamic suggests prices may continue to consolidate in the near-term before resolving this range into a new low.

Gold Daily

Gold Price Bounce, Rebound in Questions Ahead of US GDP

The technical outlook remains unchanged from last week as prices “close the week above near-term support at 1249 - a region is defined by the 38.2% retracement of the advance off the December low and the median-line extending off the May high. A break below this level targets the highlighted median-line confluence (~1220) backed by key support at 1204/10,” (area of interest for possible long-entries).

Initial resistance is eyed at former median-line support ~1284 with our bearish invalidation level now back at 1303. From a trading standpoint, I would be looking for this rebound to fade into more meaningful structural support where prices could mount a more aggressive counter-offensive.

Looking longer-term?

Click here to review DailyFX’s 4Q Gold Projections

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

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BoC Talk, “Impossible” Trade Pact, and Weak Retail Sales Hurt CAD

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BoC Talk, “Impossible” Trade Pact, and Weak Retail Sales Hurt CAD

Fundamental Forecast for CAD: Bearish

  • Bank of Canada maintained interest rates at 0.5% on Wednesday, stimulus discussed
  • Disappointing Retail Sales brings out more CAD sellers
  • Canadian Trade Minister Freeland Says Canada-EU Trade Pact ‘Impossible.'

The Canadian Dollar lost ground across the board last week as the fundamental hits keep coming. The Canadian Dollar fell to its lowest level since March 16 when the Federal Reserve dashed hopes of an interest rate hike in the near future to complement their December hike. The Canadian Dollar fell most vs. the New Zealand Dollar and Japanese Yen trading 2.53% and 1.82% lower respectively by Friday Morning.

Due to some disappointing data points after the Bank of Canada Monetary Policy Report and Press Conference, the Canadian Dollar fell from a high of 1.3005 vs. the US Dollar to 1.3350 on Friday morning after disappointing retail sales may add to Bank of Canada Governor Stephen Poloz’s comments. The yield on the Canadian 2-yr government bond fell for the fifth consecutive day for its sharpest weekly decline since June.

Looking For Clear Short-Term USD/CAD Levels Updating In Real-Time? Check Out GSI

The disappointment for the Canadian Economy started at the press-conference after the Monetary Policy Report was released and a maintaining of the 0.5% interest rate that was widely expected. Stephen Poloz noted that the Bank had discussed stimulus at their meeting, which was the kick-off on the move higher in USD/CAD from 1.3005 to the Friday morning high of 1.3350.

The capstone to the week for the weakening Canadian Dollar was a statement by Canadian Trade Minister Chrystia Freeland walked out of the negotiations with the European Union in Belgium. Freeland held a press conference after walking out saying in her native tongue, “It is evident to me, for Canada, the European Union is not capable right not to have an international pact even with a country that has European values like Canada.” Freeland also went on to say the deal seems “impossible.” For what it’s worth, this could also paint a dark cloud over pending Brexit negotiations that will look to draft up a new trade agreement once PM Theresa May and Parliament agree to trigger Article 50.

Preceding the “impossible” free-trade negotiations with EU, Friday morning saw Canadian retail sales for August drop by -0.1% vs. 0.3% estimates. The number was likely a bigger blow than a typical miss because of the Fiscal Stimulus enacted by the government earlier this year was shown in this print to not having its intended effect. On top of the headline print, there was a downward revision to July numbers. While Core CPI was in line, many were hoping the rally in Crude Oil would take CPI over the top, but it did not.

Where are financial markets heading into the fourth quarter? See our forecast and find out!

Economic Data on Deck for Canada This Week

The main economic data point for the week ahead is Monday’s Wholesale Trade Sales MoM, which will look to improve over July’s number of 0.3%. There will likely be a speech by PM Trudeau either over the weekend or early next week to discuss what the next steps will be for the trade negotiations with the European Union. He has already had stern words for the EU, and they’ll likely stay heated following Freeland’s experience in Belgium. The fundamental bent appears to remain bearish for the Canadian Economy until we see the homeland data start to pick-up beyond the recent employment surprise.

Technical & Macro Outlook: Friday’s run higher in

USD/CAD took us beyond the recently strong resistance of the 38.2% Fibonacci retracement level from January highs to May lows at 1.3312. The next key Fibonacci zone in focus is the 50% retracement at 1.3575.

Read Our Recent USD/CAD Technical Note Here

Given the significant positive correlation between the price of WTI Crude Oil and the Canadian Dollar, traders should keep an eye on the latest news surrounding the potential OPEC accord and the direction of Oil. Oil recently traded at 15-month highs, but as you can see in the chart below, the Canadian Dollar has fallen despite Oil’s rise. If Oil can accelerate higher the downside for the Canadian Dollar may be limited. However, if Oil cannot remain at or above $50/bbl, it will be difficult to see where economic growth could originate.

CAD Had a Handful of Negative Fundamental Forces Pulling It Away From Crude Oil’s Trajectory

BoC Talk, “Impossible” Trade Pact, and Weak Retail Sales Hurt CAD

Chart Created by Tyler Yell, CMT. Data Courtesy of Bloomberg

Australian CPI to set the Tone in Aussie

Price Action, Swing & Short Term Trade Setups

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Australian CPI to set the Tone in Aussie

Fundamental Forecast for the Australian Dollar: Neutral

Last week we discussed the changing of the guard at the top of the Reserve Bank of Australia. After ten years at the head of the bank, ex-Governor Glenn Stevens handed over the reins to Dr. Phillip Lowe last month. And while the Australian economy has now went 25 years without an actual recession, a lack of inflation as global growth has cooled has raised some very serious questions about sustainability of Australian growth.

Global markets are still very much in the ‘getting to know you’ stage with Dr. Lowe. This week marked his first speech as the head of the RBA, and while markets had little expectation for any near-term moves on rates; Dr. Lowe struck a balanced tone towards future cuts that helped to drive the Australian Dollar higher in the first three days of the week, with AUD/USD setting a fresh two-month high. In this speech, Dr. Lowe highlighted the fact that current low levels of inflation are not unprecedented in the Australian economy. He went on to note that since June of 1993, inflation has been below the bank’s 2% target approximately 24% of the time. But on the other hand, inflation has been above the bank’s 3% target roughly 23% of the time. Dr. Lowe continued by saying ‘what is important is that we deliver an average rate of inflation consistent with the medium-term target.’

While this does add a bit of opacity to future rate moves out of the bank, it does show that Dr. Lowe is taking a ‘big picture’ look at the situation with a great deal of historical context regarding near-term rate moves. It appears that he’s diverging from many of his contemporaries at other major Central Banks that are expressing grave concerns around lagging inflation and slower growth. This could be a positive for an Australian currency that’s dropped by -31.4% from the highs set in 2011.

While rate cuts might seem like a quick way to restore a bit of growth with some inflationary pressure, the simple fact of the matter is that this transmission mechanism appears to have seen diminishing marginal returns in many developed economies; namely Japan and Europe - each of whom went to negative rates in the recent past, but have yet to see any signs of promise or benefit in growth or inflationary numbers. While Australian rates might get nudged down in the near-future (after Q1, 2017 most likely, if at all), the RBA also has to contend with elevated asset levels in key markets, particularly real estate. This creates an uncomfortable scenario for Australian investors, and will likely need to be addressed by macro-prudential measures from the RBA should growth and inflation numbers continue to slow while asset prices remain high. This just further adds to the opaque nature of current economic projections for the Australian economy, in which slowing growth and elevated asset prices create divergent forces for the RBA to simultaneously contend with.

One benefit of this opacity is the fact that it may actually offer traders an amount of near-term clarity regarding Australian data prints. While many currencies are being driven by some extraneous driver produced from the representative Central Bank, like the prospect of more QE, this doesn’t appear to be a concern at the moment in Australia. More likely, we’re going to see markets paying more attention to Australian data as somewhat of a direct driver in the Aussie, with special focus being centered on inflationary data.

Next week brings us such a data point: On Tuesday evening in the United States (Wednesday morning in Australia), 3rd quarter GDP will be released. Current expectations are looking for .5% Quarterly growth to go along with 1.1% annualized growth. Should this number come out above expectations, we’ll likely see some element of strength in the Aussie with a miss bringing weakness into the currency.

However, due to the still opaque nature of the fundamental backdrop for the Australian Dollar, as highlighted by the dual forces of slowing growth with elevated asset prices whilst a new Central Banker takes over the top job at the bank, the forecast for the week ahead will be retained as neutral.

Will Wheeler Pose a Rate Cut Now or Wait Until November?

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Will Wheeler Pose a Rate Cut Now or Wait Until November?

Fundamental Forecast for the New Zealand Dollar: Neutral

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When the RBNZ cut the overnight cash rate in August, few probably would’ve expected what would happen next. While making the cut, RBNZ Governor Graeme Wheeler even indicated that more cuts could be in the cards should oncoming data support it; so this reduction was even accompanied with a dovish backdrop from the head of the RBNZ. But in the days following that rate move, the Kiwi continued to rally higher, moving in the exact opposite direction of what the RBNZ was likely looking for when cutting rates.

This puts the RBNZ in a difficult spot, and could give the bank some additional motivation to kick rates lower again at their upcoming meeting; although this may be a bit presumptuous given that incoming data out of New Zealand hasn’t really been bad enough to warrant rate cuts at two consecutive meetings in two short months. At this point, markets are pricing in less than a 25% chance of a cut at next week’s meeting; and more likely, we’ll probably hear some talking down of the currency rate by Mr. Wheeler as he notes the potential for another cut at their next rate decision on November 9th.

Thickening the drama is the timing of this meeting, as it takes place less than 24 hours after a widely-awaited Bank of Japan rate decision and less than two hours after Chair Yellen of the Federal Reserve finishes the press conference for their interest rate decision. Each of these can have an impact on the RBNZ’s economic outlook given how critical trends in either of those currencies can impact trade and capital flows between these economies and New Zealand: So this is just more reason for the bank to wait to pose another move on rates until later in the year.

November becomes more likely for a potential rate cut as this is when the bank will also be releasing inflation expectations; and this also gives the bank more time to evaluate data in response to the most recent cut in August. The big driver for the Kiwi will likely be how dovish the bank appears considering that the Kiwi-Dollar is trading very near an annual high. So while the RBNZ will likely try to talk this down, it looks more probable that any actual rate cuts may be waiting until November the 9th.

Because of this, we’re going to hold a neutral forecast on the New Zealand Dollar for the week ahead, with a warning of caution around this upcoming RBNZ meeting as the bank will be making the announcement in what could be extremely volatile market conditions in the wake of FOMC.

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