Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- 5 Reasons Why FX is the Market to Watch Next Week
- EUR/USD: Poised for a Rebound
- Brace for Big Moves in Sterling
- AUD Drops to 5-Month Lows
- NZD Extends Losses Despite Stronger Data
- USD/CAD Climbs to Fresh Highs
- JPY: Another Day, Another New High for USD/JPY
5 Reasons Why Next Week is Big for FX
So far, September has proven to be a big month for currencies. After consolidating for a large part of 2014, most major currencies hit multi-month and in some cases multi-year highs this past week. In almost every scenario, the moves were driven by the voracious demand for U.S. dollars but negative developments abroad also increased the attractiveness of the greenback. What makes the latest moves interesting is that they came during a relatively quiet week in the financial markets but perhaps it was the lack of market moving data that gave investors the perfect opportunity to digest and reassess the risk of holding other currencies. Next week will be an even busier one for the forex market because all of the speculation on what the Federal Reserve, Scotland and Swiss National Bank will say or do will be determined in the coming days. The Federal Reserve has one of those key monetary policy announcements that is followed by a press conference. There's a ton of U.K. data on the calendar and the Bank of England will release the minutes from its last monetary policy meeting. On Thursday, the European Central Bank will also conduct its initial Targeted Long Term Refinancing Operations (TLTRO). Regardless of whether these events exacerbate or reverse existing trends, we expect the moves to be big because they will most likely harden or alter existing market sentiment.
Considering that the U.S. dollar dictated most of the flows in the FX market this month, the Federal Reserve's meeting will be one of the most important event risks next week. The Fed is widely expected to continue tapering asset purchases, sticking to their plan to end Quantitative Easing in October. However many questions still need to be answered such as will reinvestments continue, has the central bank accelerated its timeline for raising rates and will Yellen downplay the improvements in the U.S. economy. We know the Fed plans to hold rates steady for a "considerable time" once QE ends but the performance of the dollar suggests that investors are hoping for a more hawkish statement that either involves the central bank dropping this line from the FOMC statement or Yellen admitting that rates could rise early next year. The more forward guidance the Fed provides on rates, the better it will be for the dollar. Ambiguous and noncommittal comments would be a disappointment that could erase a large part of the dollar's gains. Unfortunately given Yellen's usual disposition, chances are she will provide as little guidance as possible and for this reason we expect the dollar to trade lower on the back of the FOMC meeting.
Next Week's Top-5 FX Events
- Bank of England Monetary Policy Meeting Minutes
- FOMC Rate Decision and Testimony from Janet Yellen
- Swiss National Bank Rate Decision
- ECB TLTRO operation
- Scotland Referendum
EUR/USD: Poised for a Rebound
Between our expectations for the Fed's monetary policy announcement and the initial European Central Bank's TLTRO, the euro is poised for a rebound in the coming week. Based on the currency pair's recent consolidative price action and the rally on Friday, it appears that other investors also share our view. Of course, recovery in the euro is predicated on less hawkishness by the Fed and benign uptake of the TLTRO. The ECB made it clear when they cut interest rates earlier this month that their motivation was to make banks realize that there will be no further lowering in interest rate and they should not hesitate to participate in the TLTRO because rates aren't going lower. How successful the program is remains to be seen but if there is a significant uptake at the initial auction, it will be very positive for the EUR/USD. In contrast, if demand is weak and the Fed provides more guidance than we anticipate, the EUR/USD will fall to fresh lows. There may be a number of Eurozone and U.S. economic reports scheduled for release next week but these are the only 2 events that matter because they will set the tone for how the currency pair trades not just in the coming week but also potentially for the weeks to come. Meanwhile, the Swiss National Bank's monetary policy announcement will receive unusually large attention this quarter because the central bank could lower interest rates in reaction to the ECB's move. We'll discuss this further in the coming week.
Brace for Big Moves in Sterling
After dropping to a 10-month low versus the U.S. dollar this past week, sterling came close to recovering nearly all of its losses. The erratic price action on a day-to-day basis represents the uncertainty and anxiety surrounding next week's event risks. There is no question that the main focus is the Scottish referendum but the Bank of England minutes, inflation, employment and spending reports will also contribute to the expected volatility in the pair. For the most part, we expect most of the data and events to be positive for sterling but this does not rule out the possibility of a surprise upset in the Scottish referendum with a victory for the 'Yes' camp. The referendum is scheduled for September 18 with polls open from 7am to 10pm local time (2am to 5pm NY Time). By the early evening in Scotland we will probably have a good sense of which way the votes are swinging and sterling will start to react as soon as there is a sign of a potential majority. In the front of the week, we expect GBP to remain under pressure but come Wednesday we should start to see the currency move higher on profit taking especially if the BoE minutes are less dovish. Once the election results come in, we'll start to see a big move in the British pound.
AUD Drops to 5-Month Lows
All 3 of the commodity currencies were hit hard this past week but in terms of speed and magnitude, the Australian dollar experienced the steepest losses. AUD ended the week at a 5-, almost 6-month, low, which is surprising considering the strength of job growth and the Reserve Bank of Australia's neutral monetary policy stance. However the market's demand for U.S. dollars is strong and the fear about a further decline in iron ore prices weighed heavily on the currency. Whether Aussie continues to fall next week hinges on the RBA minutes and the FOMC rate decision. If the tone of the last RBA meeting is decidedly neutral and the Fed grows less dovish, AUD/USD will fall easily through 90 cents but if the Fed is elusive, we could see a much-needed relief rally in the currency. The sell-off in the Canadian dollar is also misaligned with fundamentals. For the second day in a row the Canadian dollar fell sharply against the greenback, driving USD/CAD to its strongest level since March. While the initial push beyond Thursday's high was driven by slower house price growth, this data should not have been significant enough to trigger such a big move in USD/CAD. Nonetheless the currency pair is in a new and strong uptrend whose viability hinges not on Canadian data but Janet Yellen's testimony next week. The New Zealand dollar, on the other hand, maintained a rather consistent downtrend despite an uptick in food prices, increase in house prices and rise in the manufacturing PMI index. This tells us that the moves in the comm dollars are driven by the market's appetite for the greenback.
JPY: Another Day, Another New High for USD/JPY
USD/JPY climbed to a fresh multi-year high every single day this week and while we are weary of a near-term pullback in the currency following Wednesday's FOMC announcement, in the long run we are still looking for USD/JPY to test 110 before the end of the year. The sharp rise in U.S. rates on Friday confirms that the primary driver of the uptrend in USD/JPY is the expectations for higher U.S. rates. If the Fed fans the speculation, USD/JPY will extend its gains but if they fail to provide sufficient guidance, a 2-to-3 yen correction in USD/JPY would not be out of the ordinary. Monetary policy in Japan hasn't contributed much to the recent rally. Yes, the Bank of Japan maintains an ultra easy monetary policy stance and is engaged in Quantitative Easing, but they have not shown any desire to increase stimulus. In fact the recent decline in the Yen reduces the urgency for more action. For this reason, next week's Japanese economic reports will be an afterthought in the context a very busy week in other parts of the world. Instead how the Yen pairs trade will be determined exclusively by what happens to the base currency.