By Dean Popplewell
The forex market has had a little bit of everything thrown at it in the past 24-hours. It looks like an asset class that wants to make up for lost time in a hurry. Finally, fundamental and technical themes are beginning to connect the dots that both volatility and volume, in the current low-rate environment, had been missing.
It's simple; all that investors want is the opportunity for price movement. From Argentinean sovereign debt defaults (albeit brief), +4% U.S. gross domestic product (GDP) growth reports, European unemployment surprises and ongoing deflation concerns, to a Federal Reserve dissenter and geopolitical risk, this market has a plethora of reasons for investors to get involved and change their approach for the remainder of this year. Tomorrow, nonfarm payrolls (NFP) data will be released with an expected +230k and a +6.1% unemployment rate. But will the report stick to the consensus headline script or will seasonal factors blow expectations away? If nothing else, this week has already been able to bring enough surprises for investors to consider changing some of their longer-term strategies lest they get burnt later on.
The Fed Stays the Course
Much higher-than-expected U.S. GDP (+4% versus +3.1%) data and an incrementally more hawkish statement from the Federal Open Market Committee has managed to push U.S. Treasury yields up, leading to a stronger USD, and slightly lower precious metals prices. U.S. 10s have succeeded in backing up +9bps into +2.54-5% territory; USD/JPY has briefly tested the psychological ¥103 figure, while December gold futures are down for the fourth consecutive day at $1,295.
To date, the Fed has been very transparent in signposting its intentions. The market expected the ongoing commitment to taper while it continues to scour for clues on rate-hike timing, which obviously depends on the Fed's interpretation of stronger data, especially in the labor sector. On the whole, no real surprises, but the Fed has been squeezed by both the market and fundamentals and is required to tread carefully.
Yesterday, Federal Reserve Bank of Philadelphia President Charles Plosser was a lone dissenter on the Committee, voting in favor of keeping the "considerable time period" clause in the statement, even as the Fed acknowledged further declines in unemployment in spite of continued "underutilization of labor resources," or in other terms, spare capacity (a phrase being used by most central banks). On inflation, the statement noted that it was somewhat closer to the Committee's longer-run objective, and the likelihood of inflation running persistently below +2% has diminished somewhat (dealers will be looking closely at tomorrow’s personal consumption expenditures index -- the Fed's preferred inflation gauge). As expected, the Fed tapered its quantitative easing program by another $10B to $25B per month. If the bank wants to finish tapering by October, it will need to up the ante in taper amount, as there are only two more meetings.
It's no surprise to see the dollar trade higher across the board (AUD sub-$0.93-cents, EUR through €1.34, JPY eyeing ¥103) and gather momentum as U.S. yields back up. With the Fed continuing to shift to a less dovish policy it should provide a more supportive stance for the dollar for the remainder of the year. Nevertheless, the markets will want to take a timeout ahead of the NFP.
Eurozone Inflation Sinks, Few Notice
This morning's expected lower "low" on eurozone headline inflation is not having much of a market impact on the single unit (€1.3385), nor are tumbling European bourses. The headline +0.4% print was already mostly priced in, and the core inflation rate remaining steady at June's +0.8% is not an influence. The eurozone's problem remains with the peripheries; Spain's -0.3% month-over-month prints and Italy's year-over-year flat rate (versus +0.2% expectation) would suggest ongoing deflation concerns. Nonetheless, European Central Bank (ECB) chief Mario Draghi and company will not be rushed to act, not at least until they can gauge the impact of the TLTRO program (targeted longer-term refinancing operations). Record-low European yields and the German bund "bull flattener," combined with the EUR's ongoing weakness, would suggest that the market is already happy to do the job of loosening policy for the ECB.
Meantime, Argentina is in a technical sovereign default after not paying its debt holders by yesterday's deadline. Currently, there is no emerging market fallout from non-payment for a number of reasons -- the risk was long-expected, and more importantly, Argentina has long been isolated from capital markets after its 2001-02 defaults. Obviously, the situation will only make the country's severe economic problems even more difficult. By day's end, emerging markets are more sensitive to a rise in U.S. Treasury yields on solid economic data. Which begs the question: will tomorrow's U.S. jobs report put the squeeze on yields again?