Very much a day for the Dollar on Wednesday

Dollar strength is very much the theme on Wednesday, with the Greenback rallying to the upside against its counterparts. Analysts were citing the previous evening’s Republican Party victory in the US Senate as the reason for the increased USD demand, but I am not necessarily buying into this explanation. One theory purposed is that with the Republic Party being very much “business focused”, the Republicans would be likely to pressure the Federal Reserve into raising interest rates sooner. However, I don’t think this is necessarily the case and the Federal Reserve are supposed to be acting independently from any political party.

Additionally, if the Republican Party are indeed more “business focused” who is to say the Republicans might not prefer to keep rates low and support business investment activity, before indicating a rate increase is expected? I understand that it could be a possibility, but it shouldn’t be conceived as the primary reason. The primary reason for the USD strength is far more likely to be due to US economic confidence being so high right now. For example, the Federal Reserve recently concluded QE and the economy is making gradual, but continual progress. Yes, a higher valued USD puts inflation targets at risk and exports have declined, but other indicators are mostly impressive and there are no indications this Friday’s NFP should disappoint.

Of course, the Dollar strength was also coupled with weakness in both the Euro and the GBP. In line with expectations, the Euro-Zone PMIs were revised lower in October and this was reflected upon negatively by investors. The EURUSD declined by close to 100 pips throughout the European session, but it shouldn’t be overlooked that at least the PMIs returned to growth in October. This provides some optimism that the weaker Euro exchange rate might be improving economic fortunes. Nonetheless, the news that the IFO had downgraded Germany’s growth forecasts while there are still concerns that Germany are entering a recession wouldn’t have helped the EU sentiment.

The GBPUSD was the main casualty on Wednesday and fell by a near 150 pips, while recording a new yearly low (1.5868) in the process. It was expected that the UK Services PMI would decline marginally in October, but the PMI came in much lower than forecast. In fact, the PMI was at its lowest in nearly 18-months. Although GBPUSD losses below 1.58 are not expected right now, a strong US employment report at the end of the week would challenge this assertion. Either way, the larger than expected decline in such a key UK GDP contributor provides another reason to expect a dovish BoE interest rate decision tomorrow.

Following inflation dropping to a five-year low, it was already expected that the Monetary Policy Committee’s (MPC) view on weak price pressures (inflation) would be even stronger in October. Wednesday’s substandard Services PMI provides even more ammunition for the BoE to cite further evidence of a slowdown in economic momentum as another reason to keep interest rates at a record low. Overall, the chances of a third member of the MPC becoming a dissenter any time soon is slim.

Since surpassing that critical $1180 support level, Gold has continued to decline with the metal dropping to its lowest level in nearly five-years on Wednesday afternoon ($1137). When Gold extended below $1180 I saw the potential for it to conclude the week around $1150, but the move has accelerated. An impressive US employment report to conclude the week could even send Gold below $1100 for the first time since March 2010.

Speaking about psychological support levels, attention should be directed towards the Aussie which just extended below the 0.8642 level moments ago. It has remained no hidden secret that the Reserve Bank of Australia (RBA) have desired a weaker AUD for a substantial amount of time, and the Australian economy has been under pressure to move away from mining reliance and transition to domestic consumption for even longer. Many economists had predicted the Aussie would conclude the year around 0.85, and extending below 0.8642 very much opens the possibility for this to happen. As always, such a move would require a combination between AUD weakness and USD strength.

Written by Jameel Ahmad, Chief Market Analyst at FXTM.

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