Since U.S. markets are closed for Labor Day we want to take this opportunity to explain why September is such a pivotal month for the foreign exchange market. Not only are investors finally back from their summer holidays and trading volumes can return to normal but we have some major event risks that go beyond this week’s 5 central bank rate decisions and non-farm payrolls report. All of these releases are important and they will help kick off the action in September but the real focus should be on the following (in order of importance):
1. September 18-19 FOMC Monetary Policy Meeting
2. September 22nd German Election
3. September 7th Australian Election
4. Japanese Consumption Tax
5. US Debt Ceiling
The most important event risk this month is of course the September FOMC meeting. The central bank has made it clear that they plan to reduce asset purchases before Bernanke steps down this year but with just over 2 weeks until the next Fed meeting, there is still no major consensus on when the central bank will act. While this week’s non-farm payrolls report will help clarify the outlook, it is looking more and more like an 11th hour decision. Aside from NFPs we will also be listening very carefully to all of the speeches made by U.S. policymakers this week for clues on where they stand. Reducing asset purchases is a major change in policy and their decision won’t be a simple yes or no. The Fed will need to decide how much to taper, which assets and whether this reduction is the beginning of a series of moves. The answer to each of these questions is crucial to how the dollar will react. If the Fed opts for a more measured move that involves only a small reduction in Treasury purchases, the dollar could weaken slightly in disappointment and if the Fed makes no changes this month, we expect the dollar to plunge. However if the central bank thinks its time to be aggressive and reduces asset purchases of Treasuries and mortgage-backed securities in a meaningful way, causing a sharp rise in U.S. yields, the dollar could soar. U.S. debt ceiling talks will also start to gain traction and depending on how difficult the discussions are this time around, we could see some additional volatility in the greenback.
In the FX market, politics can overshadow economics and this month there are general elections in Germany and Australia. The Australian elections are on September 7th and at this stage, it appears that the opposition party (right win LPA) in Australia will win, forcing the Labour party to cede control of the government. For the Australian dollar, a win by the opposition party could mean more aggressive fiscal reforms that should be viewed as positive for the currency. In Germany, election season will shift into high gear this week. There will be more talk about Greece and the need for another bailout. Merkel is not a complete shoe-in for reelection but she is expected to win and continuity would be good for Europe’s currency.
Finally the Japanese still haven’t decided what to do with the consumption tax. Prime Minister Abe supports the tax but his Administration is worried that the economy won’t be able to handle it. Recent economic data has been good but the September 9th Q2 GDP revisions will be a crucial element to the government’s decision. If Abe moves forward with the consumption, it could be viewed as positive by investors because it keeps the government on track to meet their deficit reduction targets. However if they pass on the tax, it would be positive for Japanese stocks and USD/JPY but could hurt investor confidence and weaken Japan’s fiscal position.
At the same time, expect ongoing speculation about who will replace Bernanke as the next Federal Reserve Chairman. There’s no bad choice here because both candidates are more than qualified. Janet Yellen was deeply involved with crafting the central bank’s forward guidance and would represent continuity for the central bank. She also has a more cautious demeanor like Bernanke and would be more measured on her responses to future crises. Larry Summers on the other hand is more of a wildcard and can be loose with his words, which can be dangerous for a Fed Chairman but he has extensive crisis management experience and is oftentimes considered the cleverer and creative of the two.
September is generally a busy and active month in the financial markets but with so much going on, we expect even greater activity that could lead to breakout moves in currencies.