The top 3 themes for the forex market this week are Syria, China and expectations for Fed tapering.
Syria will dominate the headlines and currency flows as the U.S. Senate prepares to vote on a limited military strike this week. President Obama will be struggling to win Congressional support for intervention in Syria and at this moment it’s a very tough call because the majority of the Senate and House are still undecided. Democrats have control of the Senate and if they reject the move, it would be a major loss for the President. For the financial markets, a strike on Syria would do more harm than good. If the Senate approves military action this week, we can expect an increase in volatility that could lift oil prices, drag stocks lower, pressure high beta currencies and spark a safe haven bid for the U.S. dollar. If the Senate rejects the action, we could see a relief rally in stocks and a continued sell-off in the dollar. When military operations began in Libya on March 19th, 2011, oil prices began a move from $100 to $113 a barrel. The U.S. dollar also rose in reaction to the strike but the gains in the greenback were short-lived and we expect a similarly knee jerk reaction in currencies in the event of military intervention in Syria.
In terms of China, a light economic calendar for the U.S. in the front of the week puts the focus on Chinese data. Continued signs of stabilization have offset some anxiety in the FX market. Last night China reported its highest trade surplus this year and there’s a reasonable chance that the industrial production and retail sales figures due later this week will also surprise to the upside. Over the past month, manufacturing activity has improved around the world and China is benefitting from the uptick in demand. If the data continues to be strong, it could provide underlying support for global equities and commodity currencies.
Reduced expectations for Fed tapering could also lead to the adjustments of long dollar positions. While we believe that the central bank could take advantage of the decline in yields and make a symbolical change in asset purchases, the outcome of their decision should be negative for the dollar and positive for bonds. Friday’s non-farm payrolls report puts the chance of Fed tapering in September versus December at 50-50 but even if monetary policy is changed this month, the move would be downplayed by a dovish FOMC statement. This week’s retail sales report is not expected to provide much help to the greenback – consumer spending should have increased in the month of August, but the momentum in spending will be weak.