By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The Federal Reserve is still actively thinking about raising interest rates in December according to the latest FOMC statement. In response, investors bought dollars aggressively after hearing the central bank say it will “determine whether it will be appropriate to raise the target range at its next meeting.” This specific December guidance sends a strong signal to the market that the Fed is looking past the recent slowdown to the prospect of stronger growth and higher inflation expectations. With 7 weeks to go before the next monetary-policy meeting, the surge in Treasury yields and rise in the dollar indicate that Wednesday’s statement has reset market expectations. However we still don’t see Fed Fund futures pricing in a full rate hike in December because its hard for some investors to believe that the Fed will raise interest rates without seeing two solid nonfarm payroll reports. Yet U.S. policymakers are encouraged by China's and Europe’s actions because they removed the line about global market troubles from their statement.
Wednesday’s FOMC announcement breathed new life into the dollar and there is typically another 0.75%-1.5% continuation after major revelations in monetary policy. The best currencies to sell versus the dollar are the euro, Australian and New Zealand dollars because the central banks of these 3 countries are either actively engaged in -- or at the cusp of -- increasing stimulus. Of course Thursday’s Q3 GDP and jobless claims reports will also be important. Now that we know the Fed wants to raise rates in December, the real test for the dollar going forward is whether U.S. data supports the case for a hike.
The New Zealand Dollar first sold off then recovered after the Reserve Bank of New Zealand left interest rates unchanged. Economic conditions did not warrant the fourth consecutive rate hike but the strength of the New Zealand dollar is a growing problem for the central bank. RBNZ Governor Wheeler said point-blank that a sustained rise in the currency would require a lower rate path and some further reduction in interest rates seems likely. RBNZ also remained hesitant about the recovery in commodity prices feeling that it is too early to affirm that dairy improvements will be sustained. The RBNZ remains dovish and for this reason we see further losses in NZD/USD -- especially after Wednesday’s FOMC announcement.
The euro was hit hard Wednesday by the “hawkish” FOMC statement. The divergence between Eurozone and U.S. monetary policy should drive EUR/USD to a minimum of 1.08. With the European Central Bank gearing up to increase stimulus less than 2 weeks before the Fed could raise interest rates, investors will be looking for every opportunity to sell euros. Bounces from here on forward should be shallow up until the November nonfarm payrolls report. Technically, the main support level to watch in EUR/USD is the July low of 1.0810 because if that is broken there is no major support for the currency pair until 1.05.
The next big focus for the market will be Friday’s Bank of Japan monetary policy announcement. According to recent surveys, 40% of investors expect the BoJ to ease, which is consistent with economist expectations. Of the 37 economists surveyed by Bloomberg, 14 expect the central bank to increase the size of its asset-purchase program and their expectations range from a 5 trillion to 20 trillion increases. Since the last monetary policy meeting on October 6, we learned that machine orders, industrial production, consumer confidence and retail sales plunged. Although oil prices prices jumped Wednesday, inflation remains low, indicating that it will be a long time before their 2% inflation target is reached. The risk of a contraction in Q3 GDP screams of the need for more easing but Japanese officials have been dismissing the need, signaling that they are in no rush to act. The Bank of Japan rate decision will be a tough call and the risk is to the upside for USD/JPY because we do not expect a big reaction to steady policy. Easing on the other hand would be very positive for USD/JPY. We can’t help but remember that a year ago, the BoJ sent USD/JPY soaring 500 pips in the 3 days after it shocked the market with more QE.
Speaking of monetary policy, Tuesday night’s surprisingly weak Australian CPI report revived talk of additional easing by the Reserve Bank of Australia next week. Consumer prices rose 0.5% in the third quarter, down from 0.7% in Q2. That left the annualized pace of CPI growth at 1.5%, well below the central bank’s 2-3% target range. Between the slowdown in inflation, weakness in China, lackluster wage growth and low commodity prices, the RBA has many reasons to act. The recent decision by Westpac to increase the cost of borrowing also adds pressure on the RBA to ease because the bank’s actions restrict loan activity. But so far, policymakers have been less pessimistic than economists. We believe the RBA’s views will have to change with the central bank needing to seriously considering cutting interest rates again at its next meeting.
USD/CAD collapsed Wednesday on the back of soaring oil prices. The price of crude has seen wild day-to-day swings over the past few weeks. On Wednesday oil rose 6% following inventory data. According to the EIA report, stockpiles rose 3.4 million barrels last week, less than the 4.1 million barrel increase reported on Tuesday by the American Petroleum Institute. The $40 mark is proving to be an important support level for oil but at the same time, $50 is an important resistance level and we expect both levels to be respected, which means 1.28 and 1.34 will remain the range for USD/CAD. Canadian GDP numbers are scheduled for release Friday and chances are the data will be weak, limiting the decline in USD/CAD.
Sterling also ended the day lower versus the U.S. dollar but with no U.K. economic reports scheduled for release and heavy euro selling, the decline in EUR/GBP limited the pound's slide.
***There will be no report on Thursday.