Between this weekend’s stronger Chinese trade numbers and Friday’s blowout non-farm payrolls report, the 3 most actively traded currency pairs (EUR/USD, USD/JPY and GBP/USD) are trending higher. Unfortunately the gains are modest and the sell-off in commodity currencies indicates that risk appetite is limited. With no major U.S. economic reports scheduled for release in the front of the week, the momentum in the market is bounded by the unpredictability of Fed policy. The latest non-farm payrolls report raised the odds of tapering next week to 50% but low inflation, weak labor participation and the upcoming holiday season also gives the central bank reason to wait. Outgoing Fed Chairman Ben Bernanke may not want to end his term being known as the Grinch of Christmas. However with the unemployment rate falling rapidly, they can’t wait much longer and it may be smarter to start the process sooner rather than later to give them the flexibility to spread the reduction over a longer period of time. In other words, the market is still divided on the timing of tapering and the lack of economic data Monday to Wednesday does not help.

The December FOMC meeting is less than 10 days away and there is only 1 piece of U.S. data between now and then that could push the central bank to lean towards earlier versus later tapering which that is Thursday’s retail sales report. If consumer spending rises more than 1% in November, the Fed will have the confidence to reduce bond purchases this month and the expectations for earlier tapering should drive USD/JPY to fresh highs. However if spending growth slows to 0.2% or less, the FOMC may choose to wait until the holiday shopping season is over and this delay could trigger profit taking in risk currencies.

Yet the retail sales report is not the only piece of event risk that could shape the market expectations and affect how the dollar trades this week. Before every FOMC meeting there is a 1-week quiet period during which no speeches can be made by policymakers. Since this starts tomorrow, we have 3 speeches by Fed Presidents on the economy and monetary policy today. This is the last chance that Fed officials have to affect public perception – if all 3 Fed Presidents talk about the risks of leaving monetary policy too accommodative, investors will interpret to mean their support for earlier tapering but if there is any reluctance and concern about the sustainability of the recovery, market expectations will shift in favor of a move in January. Of the 3 policymakers, there is one non-voting hawk (Lacker), one voting dove (Bullard) and one 2014 hawk (Fisher) speaking today.

Meanwhile, we continue to look for USD/JPY to test its yearly high of 103.74 and eventually move to 105. On a fundamental basis, the EUR/USD should be trading lower especially after this morning’s weaker German trade and industrial production numbers but the uptrend is strong and as long as the currency pair holds above 1.3675, a move above 1.38 appears likely.

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