Why Traders Bought Dollars Before FOMC

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Daily FX Market Roundup 10-29-13

Why Traders Bought Dollars Before FOMC
ECB Comments Sent EUR on Rollercoaster Ride
GBP: Breaks Down Despite Stronger Data
NZD: What to Expect from the RBNZ
AUD: RBA Thinks AUD Should be Weaker
CAD: BoC Explains Decision to Drop Bias to Raise Rates
JPY: Broad Based Improvements in Data

Why Traders Bought Dollars Before FOMC

Investors have been gradually selling dollars since the last Federal Reserve meeting but on the eve of the next central bank gathering, we are seeing a broad based rally in the greenback. Traders should not mistake the rise in the dollar for renewed demand in the currency because it represents a reduction in short dollar positions. A decline in consumer spending should have driven the buck lower but instead the currency rallied on the view that any surprises from the Fed will be to the upside. bracing for dovish comments from the central bank and have mostly priced in no taper until 2014. So the only way that the Fed could catch the market by surprise is if they brush off the recent data deterioration and appear less dovish. The chance of this happening is very slim but not out of the question because the recovery is widely expected to regain momentum in November after slowing in October. But the Federal Reserve is not one jump the gun and assume that a recovery in November will last into December. Instead they will most likely opt to wait for data to improve before appearing more optimistic because otherwise their bias could drive rates higher and endanger the recovery.

At the same time, the performance of the U.S. economy fell short of expectations in September, giving policymakers plenty of reasons to be nervous. Retail sales fell 0.1% last month and while the data could have been worse, consumer confidence and job growth also deteriorated. Demand contracted for the first time since March even though sales excluding automobile and gas purchases rose 0.4% up from 0.1% the previous month. Today’s report shows how weakly positioned the economy was before the U.S. government shutdown and unfortunately conditions were only worsened in October by the dysfunction in Washington. As a result, the U.S. could be poised for a back-to-back decline in retail sales in October. Producer prices also fell 0.1%, which was the first decline since March. On an annualized basis, PPI growth slowed from 1.4% to 0.3%, its weakest level since October 2009.

So while the dollar shrugged off the retail sales report, it may be very difficult for the Federal Reserve to ignore the lack of inflation and weak consumer spending. Despite a 0.4 percentage point decline in the unemployment rate between June and September, the third quarter was tough for the U.S. economy and while the Federal Reserve is not expected to alter monetary policy tomorrow, their description of the economy should be less optimistic. September was the last month with data u affected by the government shutdown and for the next 2 months, investors and the central bank will have discount every incoming economic report. When the Fed met in September, they said the housing market was strengthening and the labor market is showing further improvement but unfortunately both parts of the economy have deteriorated since then. In the FOMC statement the central bank could acknowledge the recent weakness and say the recovery was set back further by the government shutdown and this could be enough to solidify expectations for tapering in 2014 versus 2013.

Since the last central banking meeting, investors have had plenty of time to price in a delayed move by the Fed especially during the shutdown. In the past 2 months, the dollar declined more than 4% against the euro and Swiss Franc and over 5% against the Australian and New Zealand dollars. At 1% the sell-off in USD/JPY is modest in comparison, but investors still sold dollars against all of the major currencies. So yes, investors have positioned for no tapering this year but given the significance of the FOMC announcement, we still expect the dollar to react to the central bank’s tone but the move in the should be limited to less than 1% against all pairs.

ECB Comments Sent EUR on Rollercoaster Ride

Comments from the European Central Bank sent the EUR/USD on a rollercoaster ride today. ECB governing council member Ewald Nowotny said policymakers and investors have to live with a strong euro because a cut in the benchmark or deposit rate is unlikely. This comment sent the EUR/USD surging above 1.38 but the rally did not last for long as investors quickly realized that there was very little chance the ECB would cut interest rates again to begin with. At the same time, we know that the central bank is comfortable with EUR/USD at 1.37 but at 1.40, they may feel differently. In other words Nowotny did not say anything new and therefore the euro did not deserve to rally. Instead, the currency ended the North American trading session at its lows after investors unwound some short dollar trades ahead of the FOMC announcement. The market’s focus tomorrow will be on the U.S. central bank meeting but German unemployment and Eurozone confidence numbers are also scheduled for release. Economists are looking for the level of unemployment to hold steady but according to the PMI report, job creation slowed which points to deterioration in the labor market. On a technical basis, the EUR/USD appears to be rolling over and poised for a move to 1.3600 but that could change quickly if the Fed grows more dovish.

GBP: Breaks Down Despite Stronger Data

The British pound continued to trade lower against the U.S. dollar and euro despite relatively healthy U.K. data. Mortgage approvals rose by the largest amount in 5.5 years, signaling continued strength in the housing market. The government’s Funding for Lending Scheme and low interest rates has been a big success, providing ongoing support for the housing market. However not only did sterling fail to benefit from the news but it sold off aggressively instead. In the past 3 months, the GBP/USD enjoyed a very nice rally and the latest sell-off represents profit taking off of overheated levels before the FOMC rate decision. Recent U.K. economic data has been mixed and there’s scope for further disappointments. The Bank of England has already made it clear that they don’t plan to raise interest rates until 2016 but the market is hoping for a move in 2015 and if incoming data continues to be weak, they will need to adjust their positions accordingly.

NZD: What to Expect from the RBNZ<.h5>

Commodity currencies extended their losses against the U.S. dollar today and while the Australian dollar experienced the steepest slide, the Canadian dollar dropped to a 1 year low. The AUD was hit by comments from RBA Governor Glenn Stevens who said the currency was unusually high and not supported by fundamentals. He felt that it “was likely that AUD would fall materially given the country’s declining terms of trades.” Yet the currency’s strength may not be enough motivation for the central bank to cut interest rates because they realize a large part of the performance has to do with U.S. dollar weakness which they believe should reverse once the Fed begins to taper asset purchases. The currency was also hit by China’s leading index and with AUD/USD ending the North American trading session near its lows, the pair is poised for a move to 92 cents. The Canadian dollar on the other hand fell victim to dovish comments by Bank of Canada Governor Poloz who explained that lower inflation risk led to the BoC dropping its rate rise bias. As we have seen in today’s industrial product price and raw material reports, price pressures pose no threat to Canada’s economy and instead will allow the BoC to keep monetary policy easy for a longer period of time. The main focus tomorrow will be on the RBNZ. The last we heard from the central bank, they said interest rates will be increased in 2014. These hawkish comments sent the NZD soaring to the point where the central bank had to step in and talk the currency down. Going into this month’s meeting, the currency is well off its highs but data has also deteriorated at home and abroad. As such, the risk is to the downside for the NZD if the RBNZ sounds more cautious but at the end of the day, we still expect the central bank to stick its call to raise rates next year.

JPY: Broad Based Improvements in Data

It may have been a mixed day for the Japanese Yen but there was no ambiguity when it came to Japanese data. According to the latest economic reports, Japan’s economy continued to recover in the month of September. Consumer spending was particularly strong with household spending rising 3.7% compared to a 0.5% forecast and retail sales rising 1.8%, over 3 times more than anticipated. The jobless rate also dropped to 4% from 4.1% while the small business confidence index rose from 49.8 to 50.8. These solid economic reports indicate that the third quarter ended strongly for Japan. This should make for a more optimistic Semi-annual report, which will be released alongside the Bank of Japan rate decision. With the consumption tax scheduled to increase in April of next year, it will be important for Japan to keep up its current level of consumption in order to provide baseline support in the second quarter of 2014. Lower unemployment will help but all of these improvements need to be sustained and the Bank of Japan understands this extensively, which is why they have every intention of keeping monetary policy easy. Industrial production is scheduled for release this evening and like all of last night’s reports, an improvement is also expected in manufacturing activity.

Kathy Lien
Managing Director

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