The USD is drifting lower against its trading partners on Wednesday, with this being in response to the complete contrast in opinion as to whether the beginning of Janet Yellen’s two-day testimony can be perceived as dovish or hawkish. In my opinion, it was neither and the Federal Reserve Chairwoman just provided a balanced outlook on the US economy, which I personally believe was the right approach to adopt. My reasoning for this is that in times of such high market volatility, the last thing Yellen would have aimed to do was set off more fireworks in the currency markets, therefore she adopted a balance outlook yesterday and will likely do the same later today.
Basically, what the USD bulls needed to hear was in the message conveyed yesterday and that was confirmation that “the FOMC will be raising interest rates” which will result in the USD remaining supported in the longer term. Also delivered in the message, and this came as no surprise at all, was that the “FOMC will be in no hurry to begin raising interest rates” which has prevented the markets from getting over-excited in the short-term. Although the USD bulls will have preferred Yellen to hint at a possible rate hike before the second half of the year, the FOMC are completely right to be patient in raising US interest rates.
Moving forward, the FOMC will be closely monitoring international developments because the divergence in sentiment between the United States and everywhere else is becoming pretty eye-catching to be honest. I mean with so many central banks shifting monetary policy and unexpectedly easing, a simple neutral and cautious stance from the FOMC can be considered hawkish enough to support the USD uptrend. The other focus for the FOMC will be inflation, which it has held as a high priority for a lengthy period of time and which is facing unexpected downside pressures following the dramatic drop in the price of oil.
The EURUSD is still trading cautiously and struggling to find any direction. After appreciating to the brink of 1.14 a few hours ago as the news filtered through that Eurozone finance ministers have approved a reform proposal for Greece to be awarded a four-month extension of its bailout, the pair has quickly settled back down to 1.1342. Although the drama in Greece is at least drawing to a break in filming for the four-month period, the pressure on the Euro is far from over. It was only yesterday that Eurozone inflation had fallen at its fastest rate since records began, meaning Europe is slipping into deflation before ECB QE is even launched. Traders are now going to be paying attention to the painful EU economic performances and when the USD rallies when the timing of a rate hike approaches, the EURUSD is at risk of sinking towards the parity levels expected this year.
The GBPUSD has reached a near two-month high at 1.5537 after Bank of England (BoE) Governor Carney displayed confidence in stating that the unexpected low inflation trend is temporary and inflation will return to target within two years. This has prevented the pound from suffering weakness and allows investors to concentrate on the UK’s strong economic performances. Carney avoiding a trip down dovish street is basically good news for the EURGBP bears. When speaking of a wide divergence in sentiment, there are few that stand out further than the contrast in fortunes between the UK and Europe. With Carney appearing at ease with the unexpected UK inflation risks and very little positive news coming out of the EU economy, the EURGBP pair looks primed for future downside moves towards 0.70.
The USDCAD has been the real surprise story over the past 48 hours with the Loonie rebounding after Royal Bank of Canada (RBC) Governor Stephan Poloz surprised observers yesterday. The USDCAD has pulled back from 1.2663 to 1.2426 following Polaz pushing back expectations for another interest rate cut after suggesting the surprise cut last month provided the RBC with some time to see how the economy develops. This attracted attention but what struck me as enticing was that there was a hint from Polaz that the RCB are looking into the possibility of changing inflation targets. With low oil prices not going anywhere and time required for inflation to pick up again globally, I do wonder if the RBC are going to set a trend for other central banks to follow.
The Swedish Kronor is strengthening despite the Riksbank stating that it is ready to use additional monetary tools in its battle to combat low inflation. On the other hand, the Norwegian Kroner is weakening slightly with this possibly being attributed to concerns that the Norges Bank will not warn regarding the possibility of further easing but just ease at its next policy meeting, after the warning late last year that Norway risks a “severe downturn”. Anyway, the concerns regarding the economic outlook for both Norway and Sweden provide me with comfort that Denmark’s central bank will continue defending the EURDKK minimum exchange rate. With the Euro not being the only currency under repeated pressure but nations close to Denmark as well, it is basically in Denmark’s best interest to keep its currency weak.
The Aussie has surged from 0.7780 to a monthly high at 0.7900 following the overnight manufacturing PMI from China easing fears over the Chinese economy. I am not ruling out a potential return to 0.80 for the Aussie because the Reserve Bank of Australia (RBA) is under high pressure to reduce interest rates again next week. This is one of the problems the RBA will face now after its rate cut last month, meaning the pressure will remain on the RBA to ease further. The Aussie had already declined from an incredible 0.93 in September and I do think the RBA might now be thinking twice about whether surprising the markets last month was such a wise idea. The Aussie was declining at such a rapid rate that the RBA were better off, in my opinion, waiting for the Aussie selling to stall before reducing rates, rather than aiming to speed the decline.
Although the stronger manufacturing PMI from China has raised sentiment, it has failed to prevent the CNY from facing pressure with the USDCNY remaining around the 6.27 area. Weak inflation is the concern for the Chinese economy and with inflation unlikely to pick up anytime soon and question marks remaining regarding domestic momentum slowing down, the overwhelming consensus persists that the People’s Bank of China (PBoC) might need to reduce interest rates in the coming months to combat these two issues.
Written by Jameel Ahmad, Chief Market Analyst at FXTM.
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