Daily FX Market Roundup 12-18-13

My Top 10 Takeaways from FOMC and Bernanke
EUR: Germany is the Shining Star of Europe
GBP: Time for BoE to Reconsider its 7% Unemployment Threshold?
AUD: Drops to Fresh 3 Year Lows Post FOMC
NZD: Sharp Rise in Business Confidence
CAD: Rise in Wholesale Sales Points to Stronger Retail Sales
JPY: No Action Expected from the BoJ

My Top 10 Takeaways from FOMC and Bernanke

Today’s FOMC announcement proved to be an exciting one and as the dust settles, here are my top 10 takeaways from the announcement and Bernanke’s press conference.

1. Janet Yellen voter to taper
2. Taper nothing more than symbolic – $10B split between Treasuries and MBS
3. Fed changes forward guidance – Low rates now appropriate “well past the time that the unemployment rate drops below 6.5%”
4. Bernanke believes FOMC will taper QE probably at each meeting, $10B each time with end of QE before 2014 year end
5. Fed says tapering will be “in further measured steps at future meetings,” determined “deliberately”, data dependent
6. Bernanke stresses highly accommodative stance, emphasizes that purchases will go on at rapid rate even after taper
7. Decision was NOT unanimous – Rosengren voted to keep asset purchases unchanged
8. Majority of Fed officials see first rate hike in 2015
9. Low inflation is a problem – “more than a bit of a concern.” Fed now sees PCE at 1.4%-1.6% in 2014
10. Fed tightens up GDP forecasts, sees faster drop in jobless rate, 6.3%-6.6% by end of 2014

The Federal Reserve’s decision to reduce asset purchases today was nothing more than a symbolic move, but the symbolism should not be lost on investors because the central bank has officially began the process of unwinding stimulus. According to Ben Bernanke who won’t play a role in future decisions, the Fed will most likely taper at each upcoming meeting by $10 billion which means the Quantitative Easing program will end in 2014. His successor, Janet Yellen agreed with today’s decision. Yet the rally in the dollar was limited even though U.S. yields edged higher. USD/JPY failed to extend to 104 and after an initial rollercoaster ride EUR/USD ended the day only slightly lower. The rally in U.S. stocks tells us that investors were satisfied with the modest move, especially after central bank changed its forward Bernanke went to great lengths to explain that the move does not represent tightening, a rate hike is still a long ways away and monetary policy remains extremely accommodative. While the central bank did not lower their unemployment rate threshold, they may as well have as central doesn’t plan to raise rates until “well past the time that the unemployment rate drops below 6.5%.”

Even though interest rates will remain unchanged for the foreseeable future, the mere possibility that the Fed could reduce asset purchases at every meeting next year until bond buys hit zero is enough reason for investors to buy dollars. In our FOMC preview, we said that investors have priced in tapering this month or next but they have not discounted the pace of asset reductions or the end of QE. Now that the central bank has hinted that QE could end in 2014, 10 year bond yields could rise above 3%, creating more demand for U.S. dollars. We continue to look for USD/JPY to hit 105 and the EUR/USD to head towards 1.35.

EUR: Germany is the Shining Star of Europe

After some initial volatility, the euro ended the day lower against the U.S. dollar. Despite better than expected German data, the Federal Reserve’s plans to unwind stimulus comes in stark contrast to the dovishness of the ECB. Data out of Germany continues to shine with the IFO business climate index rising to its strongest level since April 2012. German businesses grew more optimistic in the month of November and even though the increase was in line and not better than expected, it is still indicative of momentum and strength in the Eurozone’s largest economies. Some investors were worried about the decline in current assessment but the expectations component of the index rose to its strongest level since March 2011. In other words, German businesses have not been this optimistic about future opportunities in more than 2.5 years. While this is great news for the country and the region as a whole, the ECB still needs to see this same pace of growth in other parts of the Eurozone. As German Chancellor Angela Merkel said this afternoon, “Europe is not yet over the mountain on crisis.” Rates will remain low for an extended period of time and this reality should make the euro less attractive compared to other currencies such as the GBP and NZD.

GBP: Time for BoE to Reconsider its 7% Unemployment Threshold?

One of the best performing currencies today was the British pound. Sterling soared against the U.S. dollar and euro after the unemployment rate dropped to 7.4% from 7.6% in October. Jobless claims fell slightly more than expected but the drop in unemployment and the rise in average weekly earnings have investors thinking that the Bank of England needs to revise its projections for the 7% unemployment threshold once again. In August, the BoE believed that the unemployment rate would fall to 7% in the second half of 2016 but last month they accelerated this forecast by a year to Q3 of 2015. We are now only 0.4 percentage points away from this threshold and it could easily be reached by the middle of 2014. While the central bank has made it clear that 7% unemployment is a threshold and not a trigger for a rate hike, the rapid decline in jobless rate will encourage investors to position for earlier tightening by the BoE. Come February when the next BoE Inflation Report and economic projections are scheduled for release, policymakers have a very important decision to make and two of the things they will consider include pulling forward their unemployment rate forecasts once again and/or lower the threshold. In the meantime, retail sales are due for release tomorrow. Given widespread improvements in the U.K. economy, retail sales are expected to rebound after dropping 0.7% the previous month. Good numbers could drive the GBP/USD above its 2 year high of 1.6466.

AUD: Drops to Fresh 3 Year Lows Post FOMC

The Australian dollar dropped to fresh 3 year lows against the U.S. dollar on the back of the FOMC rate decision. All 3 commodity currencies were hit by the strength of the dollar but the downtrend in AUD remains the strongest. Last night’s comments from Reserve Bank of Australia Governor Glenn Stevens provided us with a good sense of the central bank’s thinking. He is happy to see the recent decline in AUD but is still open to the idea of another rate cut or FX intervention. As the economy is expected to grow below trend for a little while longer, additional monetary support could be needed especially if the actions by the Federal Reserve cause more volatility in the financial markets. With this in mind, the RBA admits that interest rates are very low right now given the state of the economy but if needed, they will still lower rates again. While nothing Stevens said was particularly new, the fact that intervention or another rate cut is on the table sets the RBA apart from many other central banks who have a neutral monetary policy stance or are looking to reduce stimulus. The contrast with New Zealand continues to be strong with New Zealand business confidence rising sharply in December and Australian leading indicators dropping 0.1% in November. The continued momentum in New Zealand’s economy should keep the pressure on AUD/NZD. New Zealand GDP numbers are due for release after the time of publication. Economists are looking for a significant acceleration in growth. Canadian retail sales are due Friday and based on today’s sharp rise in wholesales sales and the uptick in employment, we expect an upside surprise in spending.

JPY: No Action Expected from the BoJ

With the Federal Reserve decision behind us, Yen traders will now shift their focus to the Bank of Japan’s monetary policy meeting, which begins tonight. The BoJ is widely expected to keep interest rates and the size of its Quantitative Easing program unchanged so the rate decision should be a nonevent for the Yen. However according to an article by Bloomberg quoting “people familiar with the discussions,” there is still plenty of room to increase bond purchases. Next year’s tax increase is a major uncertainty that poses an unknown risk for Japan’s economy. Depending on how consumers react to the tax, the central bank may need to increase stimulus. The BoJ maintains a dovish policy bias and believes that consumers who have known about the tax increase for almost a year now will budget accordingly. We beg to differ since consumers don’t get a sense of the pain until they actually feel it. We expect the central bank to tell us that they are on track to meet their 2% inflation target in 2-year times. The last CPI report we had was for the month of October and the data showed that annualized consumer price growth increased to 1.1%, up from -0.3% at the beginning of the year. The Nikkei rose 2% overnight despite a larger trade deficit. Japan’s trade deficit increased to 1.34 trillion yen from 1.086 trillion yen in the month of November. This was the largest trade deficit ever and driven by stronger import demand and the drag of a weak yen for a country that is a net importer of energy.

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