Will FOMC Minutes Kill the Dollar Rebound?

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Market Drivers Feb. 17, 2016

Yen seesaws on yuan turbulence
Oil drive comm dollars higher
Nikkei -1.36% Eurostoxx 1.82%
Oil $29/bbl
Gold $1202/oz

Europe and Asia:
GBP UK Claimant Count -14.8K vs. -2.9K
GBP UK Unemployment 5.1% vs. 5.0%

North America:
USD Building Permits 8:30
USD PPI 8:30
USD IP 9:15
USD FOMC Minutes 14:00

It‘s been another seesaw night in the currency market with USD/JPY dropping sharply on the yuan fix only to recover when risk flows improved in European trade. After trying to prop up the yuan yesterday, the PBOC fixed the yuan at 6.5237 more than one full figure lower than yesterday creating turmoil in Asian markets as investors once again panicked about the stability of capital markets in the world’s second largest economy.

As we have noted in the past, fundamental factors require the yuan to depreciate as growth slows and exports decline markedly. In order for China to compete effectively on the global stage its currency must decline – with some analysts looking for an adjustment of 25% or more. However Chinese officials are painfully aware of the fact that any weakening of the yuan is seen as evidence of capital flight and are trying to manage the move as smoothly as possible.

It’s very unlikely that Chinese authorities will succeed in engineering a gradual currency devaluation as markets are almost certain to react with far greater volatility than they wish. Indeed by allowing the yuan to trade in a much wider band over the past several months, the Chinese authorities have already opened the door to a much more freewheeling and turbulent exchange rate market that will continue to act more like a free float rather than the languid pace of managed float of years past.

Elsewhere, commodity dollars received a small boost in the early hours of European trade as oil prices firmed. WTI pushed closer towards the $30/bbl rate as traders continued to react to the production freeze announced by OPEC ministers yesterday. Oil remains the key driver of trade in the global capital markets as it has effectively become a proxy for risk on/risk off. It appears that crude has found a near term bottom at the $25/bbl level and if prices begin to stabilize over the next few weeks, oil will begin to lose most of its influence over the markets as macro traders attention will begin to shift to more mundane fundamental factors.

In UK, labor market data proved mildly positive with claimant count declining to -14.8K versus -3K eyed. Cable popped above the 1.4300 handle on the news, but the pair remains under heavy selling pressure after losing two big figures yesterday. For now the 1.4000-1.4200 corridor remains critical support for sterling but so far its recovery from recent swing lows has been anything but impressive.

In North America today the PPI and housing numbers will be the early releases in trade, but the focus will remain squarely on the FOMC minutes to be released at 1900 GMT. The market expects a generally neutral tone from the deliberations with little hope of any rate hike in March. The key however will be whether Fed officials express any concern about slowdown in US economic growth as a direct spillover from recent global market turbulence. If FOMC official express serious reservation about US growth USD/JPY will likely test the Asian session lows as the day progresses.

Boris Schlossberg
Managing Director

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