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Fundamental Forecast for EUR/USD: Neutral
- EUR/USD jumped higher as markets priced out any Fed rate hikes this year.
- The retail crowd has quickly reversed positioning in EUR/USD – follow with live SSI updates.
- Compares the Euro’s performance one-third of the way through the quarter to our Q1’16 forecast.
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The European Central Bank may now see that it has a problem on its hands. As soon as markets priced out the possibility of the Federal Reserve raising rates in 2016, EUR/USD immediately rallied. The underpinning of EUR/USD’s decline since May 2014 – diverging policy as the Fed looked to raise rates and the ECB looked to loosen policy further – seems to be in question. Yet now that EUR/USD has jumped back towards $1.1200, it’s time to reassess central bank policy on both sides of the pond.
First and foremost, it seems that markets are operating around the belief that major central banks will only act around policy meetings in which they were armed with revised economic forecasts to support their data revisions. The ECB is well-aware of this, which is why they chose to take on a more dovish stance in January. By doing so, they kept their credibility in check, with markets convinced that March remains a possible launching point for the next round of easier monetary policy.
Market participants will be intensely focused on what the ECB and the Fed will do next at their respective March policy meetings, the next time when either central banks update their respective economic forecasts. For the US Dollar side of the equation, there may be a bit of a floor forming in the rates market: Fed funds futures stopped pricing in a rate hike in 2016 for a time midweek last week, yet the Fed continues to beat the drum that it will be raising rates gradually this year. After a rather mixed (overall, slightly positive) US labor market report for January, any data that suggests the Fed will raise rates at least once before June this year will help insulate the greenback from further steep losses (unless recession risks increase further; the Atlanta Fed’s GDPNow tracker is suggesting quite the opposite as of February 7, 2016).
From the Euro’s perspective, it’s important to consider why the ECB cut its deposit rate on December 3 – and did not make changes above what the markets had already priced in for the QE program. Financial conditions were not considered a headwind with the EUR/USD trading nearly -5% below the ECB’s EUR/USD NEER (nominal effective exchange rate, the technical assumption underpinning the ECB’s growth and inflation forecasts) at the time of the December meeting. The ECB deemed it wasn’t time to use its “bazooka,” and the Euro screamed higher.
However, the Euro exchange rate, particularly after this past week with the US Dollar’s breakdown, may once again prove to be unpalatable for ECB policymakers:
Chart 1: EUR/USD Spot versus ECB’s EUR/USD NEER (August 3, 2015 to February 3, 2016)
A stronger EUR/USD makes the price transmission mechanism in the Euro-Zone slower, which is becoming problematic for the ECB now that the spot rate is rising above the ECB’s NEER. With the ECB’s NEER technical assumption due at $1.0900 for 2016, the closing price last week of $1.1152 was +2.31% above the ECB’s technical assumption for 2016. At its max closing level last week, this differential was +2.81%. Ahead of the ECB pre-announcing its deposit rate cut at its October meeting, EUR/USD had closed as high as +3.37% above the ECB’s technical assumption for 2015 (at the time: $1.1100).
These observations lead us to believe that we’re starting to get into the territory where ECB policy officials may start to become a bit more vocal about the exchange rate. As we stated in our Q1’16 Euro quarterly forecast, we believe that, reflexively, a stronger EUR/USD has increased the probability of the ECB acting again in March.
Going forward, as it pertains directly to the Euro, rather than a symptom of the global erosion in risk sentiment, traders may want to keep an eye on EUR/SEK. Earlier this January, the Riksbank codified its intention to intervene in FX markets. If you’re unfamiliar or want more background information, you may find the article “Riksbank Intervention Threat Aims to Lift EUR/SEK Prices” helpful.
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The Dollar suffered one of its most abrupt swoons in years until NFPs stabilized the currency. Oil and gold meanwhile generated remarkable volatility and tentative stabs at trends. Will we see more of these active markets this week?
A number of major market themes were driven this past week; but for FX, the Dollar’s remarkable volatility grabbed most traders’ attention.
The near-term rebound in GBP/USD may continue to unravel in the week ahead should the Federal Reserve’s semi-annual Humphrey-Hawkins testimony with Chair Janet Yellen highlight a further deviation in the policy outlook.
Last week we looked at the astonishing surprise decision by the Bank of Japan to move to negative interest rates.
The Australian Dollar may resume its long-term down trend after rebounding to a monthly high last week as testimony from Fed Chair Yellen reboots US rate hike speculation.
This week’s moves have put the Bank of Canada, and CAD traders in a precarious position.
Both the offshore (CNH) and onshore yuan (CNY) rates closed higher on Friday after China’s central bank raised the yuan reference against the dollar to a one-month high of 6.5314.
Gold prices rallied for a third consecutive week with the precious metal advancing more than 3.5% to trade at 1157 ahead of the New York close on Friday.
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Fundamental Forecast for Dollar: Neutral
- A rebound in Treasury Yields and the Dollar reflect the market’s press against an ambitious FOMC forecast for rates
- Fed timing speculation will be one of the key themes that has potential fuel with Janet Yellen’s semi-annual testimony
- See our 1Q 2016 forecast for the US Dollar in our Trading Guides page
A number of major market themes were driven this past week; but for FX, the Dollar’s remarkable volatility grabbed most traders’ attention. Will the Greenback finally rekindle a full trend and pull the broader FX market it once again in the coming weeks? Taking measure of the currency’s performance this past week, the range of the past 10 months held firm with the 200-day moving average keeping the floor beneath the Dow Jones FXCM Dollar Index (ticker = USDollar). However, the technical restraints doesn’t fully account for the extraordinary volatility experienced. The sharpest two-day drop intraweek in two-and-a-half years, followed by a robust Friday rebound speaks to a market more capable of transitioning to a genuine trend.
Over the past year, the Dollar’s bullish ambitions have tangibly cooled. While this hasn’t seen the currency completely lose grip, it has certainly lost the remarkable momentum through 2014. This restraint is borne from the market’s doubt of the FOMC’s ambitious monetary policy forecast. Despite the central bank’s December rate hike, the market has maintained its boldfaced skepticism of the group’s projections for its pace of tightening this year. According to the forecasts from the policy authority at liftoff, 2016 will supposedly see 100 basis points (bps) of gradual hikes. That is four moves at a standard 25 bp clip. In clear contrast, the market through swaps and Fed Fund futures show serious doubt of even one hike. That disparity was clear through 2015, with each deferment by the Fed justifying the Dollar’s waylaid advance. As of today, the disparity between market and central banks is as large as we have seen in years.
As this extraordinarily fundamental discrepancy closes (conforming to the dovish market or hawkish Fed), the impact on the Dollar will be substantial. The influence this theme holds over the market was evidenced in last week’s volatility. The dramatic two-day drop through Thursday was spurred by the troubling employment, inflation and business details of the ISM service sector report. The subsequent rebound was just as clearly launched by the January employment report. While the headline NFPs may have fallen short of consensus, its average has been a hefty positive net increase of jobs month-in-and-month-out. Moreover, the unemployment rate has dropped to a multi-year low 4.9 percent and the inflation component in wage growth swelled. Further support of this clout can seriously swing the greenback’s next trend.
In the week ahead, there are a few items of moderate importance and one that is exceptional. Import inflation, retail sales, consumer confidence and a few Fed speeches will hit the radar. However, it is Fed Chairwoman Janet Yellen’s semi-annual report on monetary policy in Congress that will give us the most definitive read on the group’s views of monetary policy timing.
Since everything in the FX market is valued on a relative basis, it is important to keep in mind the context. Even if the Fed looks like it will have to delay its ambitious forecast (likely), it could still find the Dollar outpacing its major counterparts. For example, if the US central bank is still seen managing just one hike this year; it would be extraordinary contrast to fresh efforts by the ECB, BoJ and PBoC to upgrade their accommodative stances. And, these dovish counterparts taking further steps to halt growth, inflation and financial issues is likely. As such, keeping an eye on the Chinese foreign reserves figures, Japanese GDP (Monday after next) and ECB rhetoric will be just as important in assessing the Dollar’s bearings as the US data itself.
Fundamental Forecast for the Australian Dollar: Neutral
- Aussie Dollar retreats from one-month high after US jobs data
- Yellen comments to drive relative policy bets, risk appetite trends
- Are FXCM traders buying or selling AUD/USD? Find out here!
The Australian Dollar retreated after hitting a monthly high against its US counterpart last week. The initial rally played out against a backdrop pre-positioning ahead of the release of January’s US employment data, which markets expected to confirm a dovish shift in Fed policy outlook pricing out further rate hikes in 2016. When the figures actually crossed the wires however, traders were forced to rethink this scenario (as we suspected).
While the increase in nonfarm payrolls trailed forecasts and the previous month’s outsized advance was revised a bit lower, the unemployment rate ticked down unexpectedly even as the participation rate advanced. There was good news to be had on the wages front as well: average hourly earnings grew at a brisk pace of 2.5 percent year-on-year and December’s print was revised up to a multi-year high of 2.7 percent. Economists were projecting a reading of 2.2 percent ahead of the release.
The markets appeared to be clear-cut in their response. Fed Funds futures shifted to reflect recovery in the priced-in policy outlook, front-end bond yields rallied and the US Dollar moved broadly higher against its major counterparts. The benchmark S&P 500 stock index – a proxy for market-wide risk appetite – declined in tandem to reflect fears of on-coming tightening on the horizon.
Looking ahead, a lull in high-profile event risk on the domestic front will keep speculation about the likely path of US monetary policy at the forefront. The spotlight now falls to Fed Chair Janet Yellen, who will take turns delivering her semi-annual testimony to the Finance Committees of both chambers of the US Congress.
Needless to say, traders will be most interested in hearing from the central source of FOMC strategy on where policymakers intend to steer. Comments from various other central bank officials in recent days reflect a broadly deliberative posture. However, some are seemingly leaning toward a more cautious interpretation of recent market volatility while others are more readily dismissive of it as transitory.
Clues about where Yellen falls on this spectrum may prove formative for the near-term trajectory of risk sentiment trends and Australian Dollar alike. While the Chair will go out of her way to strike a balanced tone, her representation of the FOMC middle ground ought to prove instructive on where the majority consensus is leaning. Comments hinting that the Committee’s appetite for rate hikes has diminished less than that of the markets may weigh on risk appetite, sending the Aussie lower alongside stock prices.
Fundamental Forecast for the Yuan: Neutral
- PBOC says China’s Economy Will Continue to Face Pressure in 2016
- China Eases Lending Standards to Boost Housing – Will it Work?
- What Are the Traits of Successful Traders? Get FXCM’s Free New eGuide
Both the offshore (CNH) and onshore yuan (CNY) rates closed higher on Friday after China’s central bank raised the yuan reference against the dollar to a one-month high of 6.5314. Looking forward from February 7 to February 13, Chinese financial markets including equities and onshore exchanges will be closed for the Lunar New Year; the offshore yuan market will be open with normal hours. PBOC will NOT publish the daily yuan reference rate during the holiday week. However, this does not mean that PBOC will not intervene the offshore foreign exchange market if they see excessive volatility. As Chinese domestic markets will be relatively quiet in the coming week, major event risk for the yuan will likely come from overseas with specific focus on Japan and the world’s largest economy, the US.
The PBOC’s latest moves on the Yuan reference rate have sent out two important signals: 1) the regulator remains consistent with its earlier statement that “China has no intention to devalue the currency or start a trade war,” despite the recent Yuan short speculation. And 2) the central bank has made preparation for potential Yuan shorts during the holiday season; the pace of raising the reference rate was increased in the past two days. The reference rate was stronger by 105 basis points on Friday and 102 basis points on Thursday compared to an average 15-bps daily move over the past 19 days after the central bank began to stabilize the currency. This 200 point-range provides a buffer area for Yuan moves even without a reference rate. This is like leaving home for vacation and you know that the weather will be colder in your home upon your return, so you turn on the heat before you leave in preparation. Setting the reference higher is the PBOC turning on its heat before leaving for the holiday. Investors and traders should not be surprise to see “cold weather” in the coming days, which for Yuan is a bearish position.
But remember, this does not mean that guidance on the exchange rate will be foregone, especially if the Yuan rate becomes too volatile. So even though they’re on vacation, someone will still be watching the house; just in case. The central bank will keep a close eye on the currency and use other tools to defend it if massive Yuan selling begins. The PBOC can use open market operations in offshore markets, just as they hit HIBOR with a 66.82% rate less than a month ago to shake short-sellers out of the market.
As Chinese financial markets will be closed next week, event drivers for the Yuan will likely come from abroad next week. Without a Daily reference rate from PBOC to guide the Yuan, market forces may play a larger role than usual. Japan is the only major country in Asia that doesn’t celebrate the Lunar New Year; South Korea and Singapore both do. The BoJ has no scheduled announcement next week, but Japan’s trade figures will be released and China is one of its largest trade partners, so this could have some Yuan impact. From the US side, the big event is Federal Reserve Chair Yellen’s twice-a-year testimony in front of Congress. Her tone on monetary policy will move the dollar pairs, including USD/CNH.
Overall, the Chinese yuan is likely move lower over the next week without the daily guidance; unless its counterparties fall significantly driven by key events.
Fundamental Forecast for CAD: Bearish
- Canada’s Dollar Faces Key Price Test as Oil has stalled its rise and the US Dollar’s next move is uncertain as many arguments arise about Fed hikes in 2016.
- Canadian Dollar unlikely to gain further at prior pace versus US Dollar per the Speculative Sentiment Index
- Canadian Dollar Strength Halted As Friday’s News Announcements Renew Fear of BoC Action
This week’s moves have put the Bank of Canada, and CAD traders in a precarious position. From the Bank of Canada’s position, you have a stronger currency as the CAD continued rallying this week while at the same time, the data is showing less stability in the economy. Should this trend continue, we’ll eagerly look to the March 9th Bank of Canada meeting for a less confident tone from Stephen Poloz, which could continue the weak CAD theme.
Friday quelled many of the traders who thought the CAD would continue strengthening without rest. In fact, many commodity currencies end the Friday near lows of the day as the supportive US economic data rekindles thoughts about a rate hike from the Fed could further hamper commodities and global trade.
Canadian unemployment rose as Alberta, home of Athabasca tar sands, had the highest unemployment since 1996. The Employment change of -5,700 was a disappointing follow-up to January’s 24,100 job gain. In addition to the employment number the housing starts missed survey estimates of by a large margin of 20,000.
Suggested Reading: WTI Crude Oil Price Forecast: Oil Bulls May Soon Have Reason to Cheer
Next week, the economic prints carry less significance than we just saw that could leave a bad taste in traders and the Bank of Canada’s mouth. The important data next week ill be in the manufacturing industry that has been much less robust than the exporting side of the economy that the Bank of Canada praised as resilient on the back of a weaker Canadian Dollar.
From a sentiment perspective, we’ve seen traders through our speculative sentiment index or SSI fighting the latest move as USD/CAD has dropped. Toward the close of the week, traders were nearly flat with a small short bias. This move represents a substantial shift in retail forex trader positioning over the last two week. Our data shows there are currently 1.13 open retail short positions in the USD/CAD for every one that is long as 47% of traders are long. As you can see on the # of bullish & bearish orders below, this represented a notable swing from three weeks ago when that ratio exceeded 4 to 1.
In early 2015, we saw similar moves in sentiment that were developing as price retraced a good bit of the prior trend. However, when the retail sentiment turned net short and by an increasing margin, the move higher resumed. If the net short bias is able to reassert itself, we could soon see the price trend in USD/CAD resume higher as well.