Fed's Game Shifting? Heavy Bids Into USD Ahead Of NFP

Includes: FXE, UDN, UUP
by: FXstreet

Risk assets were given a slap on the face in the last American session, finally surrendering two consecutive days of notorious gains - the S&P 500 had averaged +2% gains - after Thursday's FOMC minutes sounded more hawkish than expected.

From the minutes: "A few members thought asset purchases would likely be warranted until the end of 2013, while several others thought that purchases were likely to slow or stop well before the end of 2013".

There might be other reasons why risk-sensitive instruments failed, as NAB notes. "A combination of profit taking, a temporary fix on the fiscal cliff before a full resolution as the US debt ceiling ..." however, what the market factored into yesterday's falls, best reflected by a dramatic rise on the USD, is the reassessment over how long Fed's asset purchases may last.

Nomura economist Ellen Zentner expects the FOMC "to continue its long-term asset purchases through the end of the third quarter of 2013" Ellen adds.

Chief U.S. economist at Capital Economics, Paul Ashworth, seconds Nomura's analyst view, noting: "Ultimately, it is the prevailing economic conditions that will determine when the Fed halts or slows the pace of its asset purchases," adding that "we suspect that another year of lackluster economic growth in 2013, coupled with only a modest improvement in the unemployment rate, will persuade the Fed to sustain QE into 2014," the analyst concludes.

As Kathy Lien, founder at BKAssetManagement, notes that the main motivation for ending QE by some Fed members "has less to do with their optimism about the U.S. economy and more to do with their concern about the effectiveness of additional asset purchases and the costs that it would have on the financial markets..."

"The Fed is still committed to keeping interest rates near zero until the unemployment rate hits 6.5% but if labor market conditions continue to improve, they may opt to curtail other programs. If they choose to do so, regardless of the motivation, the U.S. economy will be left with less stimulus and that is positive for the U.S. dollar. The main takeaway is that the Fed is trying to separate QE from ZIRP but they won't take any new steps until the second quarter at the earliest" Kathy adds.

For now, whether or not the USD gains can be sustainable, the non-farm payrolls data - due today at 13.30GMT - will be the best barometer to gather clues over the possible USD prospects for the month of January.

Plausible scenarios on the EUR/USD were yesterday assessed by Richard Lee, analyst at FXstreet.com:

With estimates now hovering the 150,000 mark, anything at or above would propel higher beta (or riskier) currencies like the EURUSD. Between 100,000 to 150,000. Although not as bullish, the median alternative would remain supportive for euro strength. The worst case scenario, a lower than 100,000 count would be damaging to current expectations. The scenario would be widely Euro bearish, and likely extend the current weakness towards 1.30.

One of the banking institutions quite bullish on the USD ahead of the NFP report is RBS, recently sending a trade recommendation to its clients to short EUR/USD at 1.3065, with target set at 1.2650, and a stop-loss above 1.3310, "a level which has acted as resistance twice in the past month and may have formed a double top," RBS strategist Brian Kim notes.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.