Dollar Takes Flight as FX Traders Prepare for FOMC

Daily FX Market Roundup 09.16.16

The U.S. dollar soared against all of the major currencies on Friday on the back of stronger inflation data. Sterling was hit the hardest by Brexit headlines but big losses were seen all around. In many ways today’s price action may be a reflection of positioning ahead of next week’s FOMC meeting. We are not looking for the Federal Reserve to hike rates and based on the 20% probability of a hike according to September Fed Fund futures, the market shares our view. However there’s a very strong chance that Janet Yellen will set the stage for tightening in December. Federal Reserve meetings are always important but in September Janet Yellen holds a press conference and the central bank releases their latest economic projections. We would be shocked if the central bank hiked rates in the face of falling consumer consumption, slower job growth, and significantly weaker activity in the manufacturing and service sectors but an argument can still be made for December tightening.

The only reason why some investors are holding out hope for a September hike is because U.S. policymakers have suggested so. We’ve heard a number of Federal Reserve Presidents/Governors say their goals are being met and rates need to rise. And the only reason why the Fed would pull the trigger is to avoid hiking right after the election and before the holiday season. With all of this in mind, we do not believe the central bank will raise interest rates next week but they WILL take the opportunity to remind investors that a hike is on the table for December. As traders, what this means is the dollar is a buy on dip pre and post FOMC as investors latch onto the idea the Fed is still the only major central bank talking / thinking about tightening.

The Bank of Japan also has a monetary policy announcement. Despite the Japanese government’s persistent stimulus programs, we’ve seen very little momentum in the economy. Recent economic data showed further deterioration and there’s now talk that the BoJ may be considering delving deeper into negative rates. More needs to be done but the central bank’s hands have been tied for some time and intervention has not been seriously considered. Chances are the BoJ will leave policy unchanged but there could be some operational changes with the central bank buying fewer long term bonds and more short term bonds which is mildly Yen negative. They could also remove their timeline for reaching their 2% inflation target. All of these are minor changes and investors will probably end up disappointed and for this reason, we could see further Yen weakness.

The third monetary policy announcement will be from the Reserve Bank of New Zealand. Unlike the U.S. and Japan, New Zealand’s economy has been more balanced since their last meeting. We’ve seen both improvements and deterioration with dairy prices rising and GDP growth accelerating. Manufacturing activity slowed but only modestly. Recent comments from RBNZ officials have been optimistic but when the central bank last met, they said they “will” ease further. The central bank lowered rates by 25bp in August, which was less than investors anticipated. No rate cut is expected this coming week but continued dovishness could lead to losses for NZD.

The Australian dollar was unfazed by last week’s disappointing employment numbers and in the coming week we only have the minutes from the last Reserve Bank of Australia meeting scheduled for release. If you recall, the RBA statement was relatively neutral with the central bank saying “recent data suggest that overall growth is continuing, despite a very large decline in business investment, helped by growth in other areas of domestic demand and exports. Labour market indicators continue to be somewhat mixed, but suggest continued expansion in employment in the near term.” If this sentiment is echoed in the RBA minutes AND the RBNZ is dovish, it could mark a bottom for AUD/NZD.

There were no major Canadian economic reports released last week but that did not stop the loonie from falling sharply against the U.S. dollar. The move was driven entirely by oil, which dropped as low as $42.74 a barrel.
In response, USD/CAD almost reached its 3 month high. The downtrend in oil has been strong but traders are now watching to see if prices find a bottom above $40 a barrel. Canadian retail sales and consumer prices are on the calendar but these reports won’t be released until Friday which means in the first half of the week, CAD will continue to take its cue from the market’s appetite for U.S. dollars and oil.

EUR/USD spent the whole week in consolidation mode within a narrow 80 pip range before breaking lower on Friday. The currency pair is still holding above the 200-day SMA near 1.1145, which is the level to watch next week. Between the Federal Reserve’s monetary policy announcement and September Eurozone flash PMIs, we can be assured there will big moves in EUR/USD. The direction will be determined by FOMC but if the dollar rallies after the Federal Reserve’s rate decision and Eurozone PMIs decline, we could EUR/USD hit 1.10.

Finally the focus will shift away from sterling next week. The UK’s heavy economic calendar put sterling on center stage last week but it wasn’t until Friday when Brexit headlines hit the wire that sterling broke down.
According to Bloomberg, the U.K.’s Johnson said Brexit talks are likely to start early next year which isn’t surprising but according to Chancellor Hammond, they are ready to “accept that Britain may have to give up membership of the European Union’s single market — and U.K. banks’ crucial access to clients on the continent — to achieve the immigration restrictions that voters have demanded, according to two officials familiar with his thinking.” If true, this is a major sacrifice that sterling won’t be able to handle. Meanwhile the Bank of England left interest rates unchanged and provided very little guidance on their future plans. We know that rates could and may still fall especially if there is a lot of uncertainty after Article 50 is invoked but for the time being they are in wait and see mode after having just unleashed an aggressive stimulus package in August.

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