Why FOMC Was Positive For The Dollar

Why Was FOMC Positive For The Dollar?

It may seem like investors bought dollars aggressively after the Federal Reserve’s monetary policy announcement but none of the major currency pairs moved more than 0.5%. Yet some people may be surprised that the dollar rallied at all. The Federal Reserve did not alter monetary policy and there were only subtle changes to the statement but the dollar traded higher, equities sold off and bond yields recovered its losses to end the day up nearly 3bp. This consistent performance across different asset classes suggests that the message from the central bank is clear. So lets take a look at what they said or more accurately didn’t say to make investors pile back into the currency.

According to the FOMC statement, the Federal Reserve is not worried about the sluggish pace of job growth – in fact they feel that labor market conditions have improved. They made no mention of the disappointments in nonfarm payrolls or the prospect of weaker job growth in October. They did say that the unemployment rate remains elevated but this was not a change from past FOMC statements. More importantly, the central bank is no longer worried about tighter financial conditions, which could have slowed the recovery. With stocks rallying and bond yields moving lower, financial market conditions have improved, eliminating the central bank’s immediate concerns about higher mortgage rates. Along these same lines, the Fed did not say that tapering should be postponed until 2014. Instead they will continue to monitor incoming data and assess whether it is appropriate to adjust the level of asset purchases, leading some investors to believe that asset purchases could still be reduced this year. We believe that the central bank will wait until March of 2014 to make a move but the mere possibility of December tapering, no matter how small it may be was enough to cause a pop in the dollar. The bottom line is that the dollar rallied because the FOMC statement wasn’t nearly as dovish as the market anticipated and even included a few hints of optimism.

When it comes to currencies, positioning is very important. Many investors added to their short dollar trades after the September FOMC meeting on the expectation that the Fed will not taper until 2014. By leaving the option open for a reduction this close to the December meeting, the Fed scared some of these investors into squaring up their positions. We would not be surprised if the dollar extended its gains in the Asian and European trading sessions but with the central bank still deciding when to change monetary policy, we don’t anticipate any breakout moves in currencies. Another way to look at this is that the ranges we have seen so far should remain intact until next Friday’s nonfarm payrolls report. The Chicago PMI index is scheduled for release Thursday and along with the weekly jobless claims report. There’s a reasonable chance that the weakness in NY and Philadelphia manufacturing activity spilled over to Chicago, which would be negative for the dollar.

Is The Euro Rolling Over?

A series of lower highs and lower lows in the EUR/USD suggests that the currency pair is in the early stages of rolling over and gearing up for move down to 1.36. Technicals point to a stronger sell-off but the fundamental outlook is not as clear. Over the past two months, the rally in EUR/USD was driven primarily by the reduced expectations for Fed tapering, which pressured the dollar lower. Wednesday, the FOMC left open the option to taper in December triggering a quick recovery in the dollar. The move in the euro had little to do with European fundamentals outside of the central bank’s tolerance for a stronger currency. Since the U.S. central bank did not officially postpone tapering to 2014, we could see further profit taking on short dollar positions that could compound the losses for the euro. However a number of European economic reports released this morning show that the euro-zone economy is not faring nearly as poorly as some investors may think. Confidence increased in the month of October, which is consistent with an uptick seen in investor confidence. German unemployment rolls increased slightly in October but the rise was small and still indicative of improvements in the euro zone’s largest economy. German retail sales and consumer confidence figures are scheduled for release Thursday and given the drop in the Retail PMI index, the data could surprise to the downside and, if we're right, the combination of U.S. dollar strength and weaker euro-zone data could turn the mild sell-off in the EUR/USD into a near-term top.

GBP: Fourth Straight Day Of Losses

With no U.K. economic reports released Wednesday, the British pound was at the whim of the market’s risk appetite and its demand for dollars. Sterling continued to decline off of overheated levels, falling for the fourth consecutive trading day against the greenback. Investors bought dollars aggressively after the FOMC rate decision, sending GBP/USD for a brief test of 1.60. If the dollar does not correct, there is a very good chance the currency pair will break below this key level. Incoming economic data suggests that the U.K. economy is losing momentum but after three months of back to back improvements, the positive upside surprises had to come to an end eventually. This does not mean that the recovery has peaked, but it may be a while before we see upside surprises resume. Given our outlook for weaker manufacturing activity in the month of October, we believe that it should only be a matter of time before the GBP/USD breaks below 1.60 once again. Consumer confidence numbers were scheduled for release Wednesday evening along with Nationwide House Prices. Economists were looking for an improvement in sentiment but we saw risk to the downside.

NZD: RBNZ Maintains Call To Raise Rates

The Australian, New Zealand and Canadian dollars ended the day unchanged against the greenback. While the market was focused on the Fed meeting, the Reserve Bank of New Zealand also had a monetary policy announcement that helped NZD recover post FOMC. As expected the central bank left interest rates unchanged and their commitment to raising interest rates in 2014 put a bid under the currency. The RBNZ had previously expressed concerns about the high level of the currency and they said Wednesday that currency gains provide flexibility on rate increases but made no mention that it would affect their plans to tighten policy next year. The housing market is key. If “high house price inflation persists,” the RBNZ would be pressed to act but if the recent restrictions on loans help to slow house price inflation, they can afford to wait. With the central bank still talking about tightening, we could see a renewed rally in NZD. It is also worth mentioning that rating agency Moody’s said it discussed stripping New Zealand of its AAA rating. While no action was taken, this public announcement served as a warning to investors that the country’s current account deficit could become a problem if investors start to abandon the currency. The country is heavily reliant on foreign investment and has “the largest negative net international investment position” of all Aaa countries. However a downgrade by Moody’s would not be the end of the world for NZD because S&P and Fitch stripped the country of their top rating back in September 2011. Moody’s would only be playing catch up if they decided to downgrade New Zealand, which they did not. No major economic reports were released from Australia and the calendar was quiet with only building approvals, import and export prices scheduled for release. Canada on the other will release its August GDP numbers. Growth is expected to slow significantly due to weaker retail sales and trade activity.

JPY: What To Expect From The BoJ

The Japanese Yen traded lower against all of the major currencies Wednesday on the back of a less dovish FOMC statement. With the Federal Reserve meeting now behind us, the focus can shift to Wednesday night’s Bank of Japan’s announcement. The BoJ was widely expected to leave monetary policy unchanged, which should make the rate decision a nonevent for the Yen. Still the semi-annual economic outlook report was also due for release and changes in GDP or Inflation projections could affect USD/JPY. We don’t anticipate any changes to the inflation, which is expected to reach their target of 2% in the 2015 Fiscal Year but their GDP forecasts could be upgraded. If the central bank raises its outlook for 2013 or 2014 growth, Japanese stocks would probably extend their gains, lifting USD/JPY. However if they lower their 2014 GDP forecasts, which is unlikely, USD/JPY could weaken as Japanese stocks sell off in disappointment. Data in general has been good including last night’s industrial production report. Manufacturing activity growth fell short of expectations but rebounded significantly in the month of September after contracting in August. The miss is not a major concern because manufacturing output is still moving in the right direction and should bode well for growth in the coming quarter. According to a projection survey of manufacturers, output is expected to increase in the month of November, which is consistent with our view for a continued recovery in Japan.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.