Dollar Grinds Lower Ahead of Fed Meeting

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Daily FX Market Roundup 09-16-13

Dollar Grinds Lower Ahead of Fed Meeting
EUR: Downside Risks for German ZEW
GBP: Rightmove Triples Forecast for House Price Growth in 2013
AUD Extends Higher Ahead of RBA Minutes
NZD Shrugs Off Weaker Data
CAD – Housing Market Gains Momentum
Long USD/JPY Positions Still at Elevated Levels Ahead of FOMC

Dollar Grinds Lower Ahead of Fed Meeting

The U.S. dollar traded lower against all of the major currencies today and we expect this trend to continue ahead of Wednesday’s FOMC rate decision. According to the latest CFTC IMM data, investors are still significantly long dollars and given the latest economic reports, have stronger reason to square their positions ahead of the announcement. The amount of asset purchases reduced per month, if any at all will not be the only trigger for volatility on Wednesday, forex traders will also need to watch how the Fed changes its economic projections and their forward guidance. It is a close call but we believe the central bank will reduce Treasury purchases this week by $5 billion to $10 billion per month and we also expect Bernanke to downplay the significance of tapering at his press conference. If the central bank wants to avoid sending U.S. yields sharply higher, they will need to convince the market that tapering will not lead to tightening and we believe they will go above and beyond to do so.

Meanwhile a multitude of factors contributed to dollar weakness today including economic data, speculation about the next Fed Chairman and Syria. According to the latest economic reports, the recovery in the manufacturing sector is losing momentum. In the NY region, manufacturing activity dropped to its lowest level in 4 months with the Empire State index falling to 6.29 for the month of September from 8.24. Over the past few months, weaker activity in NY has not coincided with slower activity across the nation, but this is another piece of data that will challenge the central bank’s monetary policy decision. Industrial production accelerated in the month of August but the increase was less than the market had anticipated and was also the fifth month in a row that IP missed expectations.

Over the weekend, Larry Summers withdrew his name from consideration as Fed Chairman. Compared to Janet Yellen he was largely viewed as the bigger friend to the dollar. While Summers and Yellen are both doves who feel growth is a bigger risk than inflation, Yellen played a key part in designing the central bank’s Quantitative Easing program and more recently, was a big advocate of forward guidance. Summers on the other hand did not shared his views on monetary policy but his unpredictability and potential for unscripted comments means he could have caused more volatility for the financial markets. While he was President Obama’s preferred candidate his decision was motivated by his concern that Obama would not be able to rally the Senate behind his nomination. Yellen was the more dollar negative candidate and now that she has become the clear front-runner, the currency has traded lower across the board.

The greenback also lost its safe haven bid after the U.S. and Russia reached a deal on Syria over the weekend. Syria must submit a comprehensive list of its chemical stockpiles in 1 week and allow international inspectors to be on the ground no later than November. All chemical weapons must be destroyed or removed by mid 2014 or the U.N. would have the authority to use force. With a military strike no longer an imminent threat, the U.S. dollar and the price of oil have moved lower.

EUR: Downside Risks for German ZEW

The euro appreciated against the U.S. dollar today but ended the North American trading session well off earlier highs. Eurozone consumer prices and labor costs were the only reports released from the region and both numbers had very little impact on the currency. The fluctuations in the euro coincided with the moves of other major currencies, which indicates that the market’s appetite for dollars was behind the move. The most important Eurozone report scheduled for release this week will be Tuesday’s German ZEW survey of investor confidence. Analysts are looking for sentiment to improve but with economic data taking a turn for the worse, Italian politics in flux, and Syria posing a geopolitical risk to the markets, we would not be surprised if investor confidence weakened. The German election this weekend will also be a focus for the euro and while Angela Merkel will most likely be re-elected, her victory is far from assured. For the financial markets, a third term for Merkel would probably trigger a small relief rally in the DAX and euro. Continuity is good for the currency and a big market reaction would only occur if the opposition party wins. According to a study by JPMorgan of the last 4 national elections (Greece, France, Netherlands and Italy), the euro “range traded in the month leading up to the elections and declined 3 cents in the month that followed.” While this trend may be strong, they attribute the move to cyclical rather than political factors.

GBP: Rightmove Triples Forecast for House Price Growth in 2013

The British pound traded higher against the U.S. dollar but has yet to test the 1.60 level. The only piece of U.K. data released today was Rightmove house prices and according to the report, prices fell for the second month in a row by 1.5%. The agency attributes the decline to a slow summer season, which the director of Rightmove called the “norm in August.” Instead investors chose to focus on their projections for a strong rise in prices this year. Rightmove raised its forecast for 2013 prices 3 fold from 2% to 6%. They said that “while prices fell during the month overall, the last couple of weeks have seen the start of a turnaround, with more sellers choosing to come to market and pitching higher prices as momentum builds. This month’s failure to deliver fresh supply and the resulting fall in property on agents books will prime the pump for an autumn price surge as buyer confidence and activity continues to increase.” A rapid rise in the value of homes accompanied by an improvement in the economy could prompt the Bank of England to unwind its Quantitative Easing program or raise interest rates sooner than 2016. Inflation plays a big role in that decision and tomorrow, U.K. consumer and producer prices are scheduled for release. CPI is expected to increase but even with the rise, inflationary pressures in general have been muted.

AUD Extends Higher Ahead of RBA Minutes

The Canadian, New Zealand and Australian dollars were the leading beneficiaries of U.S. dollar weakness. All 3 currencies traded sharply higher despite mixed economic reports. The New Zealand dollar rose to a fresh 4-month high even after traders learned that service sector activity slowed in the month of August and consumer confidence dipped in the third quarter. Like the manufacturing sector, growth slowed in services last month but the data represents a retracement off of 6-year highs. The hawkishness of the RBNZ caught many investors by surprise last week and while the latest economic reports may moderate their optimism, both sectors of the New Zealand economy are still in expansionary mode. At the same time, the housing market is a primary area of concern for the central bank and the latest increase in house prices could reinforce their commitment to cooling the bubble. Meanwhile existing home sales in Canada rose 2.8% in August but foreign investors bought less Canadian dollar denominated assets in July. These second tier reports had very little impact on the loonie. Looking ahead, the focus will be on the Australian dollar. The minutes from the most recent Reserve Bank of Australia monetary policy meeting will be released this evening. While the market was surprised by the weakness in the labor market, the RBA left interest rates unchanged and removed the words “scope to easing policy further” from their September statement which many interpreted to mean no more rate cuts this year. If the RBA minutes convey an overall sense of optimism, the AUD/USD could test 94 cents.

Long USD/JPY Positions Still at Elevated Levels Ahead of FOMC

While U.S. dollar weakness drove USD/JPY lower today, the other Yen crosses held up much better thanks to the improvement in risk appetite. There was no Japanese data on the calendar and monetary policy officials were very quiet, leaving the drop in U.S. yields as the primary driver of USD/JPY flows. Despite the deterioration in U.S. data, traders added to their long USD/JPY positions according to the latest CFTC IMM report. The report released on Friday showed that speculators raised their short Yen exposures to its the highest level since May 28th. While this data is often viewed as stale, because it tracks positions as of Tuesday, these numbers account for positioning after non-farm payrolls. In other words, speculators saw last month’s disappointing jobs report and still bought more dollars versus the Japanese Yen. This means there could be more position squaring in USD/JPY ahead of the FOMC announcement and aggressive liquidation if the market interprets the outcome of the meeting as dovish. There are no major Japanese economic reports scheduled for release over the next 24 hours, which means U.S. yields and risk appetite will continue to drive Yen flows.

Kathy Lien
Managing Director

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