USD: Fed Officials Hint of Potential Tapering in December

• USD: Fed Officials Hint of Potential Tapering in December
• GBP: Closing in on 2 Year Highs
• AUD: Risk of Downside Surprise in Chinese IP
• AUD: Construction PMI Hits Highest Since April 2010
• NZD: Gold Down 1.5%
• EUR: Shrugs Off Weaker German Data, Hits 1 Month Highs
• Nikkei Rally Drives Yen Crosses to New Highs

USD: Fed Officials Hint of Potential Tapering in December

The Federal Reserve is preparing to wind down its Quantitative Easing and they are widely expect to make the first move within the next 2 months.  However few can agree on the exact timing and for this reason, even though Friday's labor market report was very good, currencies consolidated today. The dollar extended slightly higher against the Japanese Yen but weakened versus the euro and British pound. No major U.S. economic reports are scheduled for release in the front of the week and the momentum in the forex market is bounded by the unpredictability of Fed policy.  However based on today's speeches by Federal Reserve officials, policymakers may be more willing to begin their reduction in asset purchases in December than most expect. 

Of the 3 Federal Reserve Presidents scheduled to speak today, Bullard is the only voting member of the FOMC this year.  He said the Fed should acknowledge the improvements in the labor market and the odds of Fed QE taper increased with those. However los inflation means that taper should start small and this reasonable suggestion is one that we believe the central bank will heed especially if they start reducing their monthly bond buys this month. Bullard is typically one of the most dovish members of the FOMC and his acknowledgement of labor market gains and discussion of the size of taper suggests that he is on board with a small reduction this month.  Fisher is non a voting member of the FOMC this year but he votes in 2014. As one of the most hawkish members of the central bank, it is no surprise that he feels the Fed should taper at its earliest opportunity.  He believes there's scope to dial back asset purchases next week.  Lacker does not get to vote until 2015 but he stated the obvious, which is that the central bank will discuss reducing its QE program when they meet later this month.  On forward guidance Lacker suggests telegraphing the path of QE tapering but Bullard opposes setting any specific timetable for ending asset purchases.   As for reducing the 6.5% unemployment rate threshold, both Lacker and Fisher don't think it's a good idea.

Looking ahead, the odds of December tapering still stand at 50% with these comments.  The next FOMC meeting less than 10 days away and there is only 1 piece of U.S. data between now and then that could push the central bank to lean towards earlier versus later tapering and that is Thursday's retail sales report.  If consumer spending rises by more than 1% in November, the Fed will have the confidence to reduce bond purchases this month and driving USD/JPY to fresh highs.  However if spending growth slows to 0.2% or less, the FOMC may choose to wait until the holiday shopping season is over and this delay could trigger profit taking in risk currencies. 

GBP: Closing in on 2 Year Highs

The British pound is closing in on its 2 year high of 1.6443 against the U.S. dollar.  No U.K. data was released this morning but Bank of England Governor Carney spoke in NY today and based on his speech, he is still very comfortable with the current level of monetary policy. Carney said inflation cooled more than they expected this year but he is alert to the risks of extended stimulus. While they believe U.K. economic news has been positive and the performance of the housing market merits vigilance but not panic, he said interest rates won't return to normal levels any time soon.  Demand in the euro area is still lacking and both the U.K. and U.S. economies are a long way from normal.  When asked about their forward guidance (the 7% unemployment rate threshold), he said it is too early to think of changes.  So while the central bank has grown more comfortable with the performance of the economy, they are also in no rush to change monetary policy.  However this optimism has been enough to keep sterling supported.  Industrial production and trade data are due for release tomorrow and given the proximity of the 2 year high, these reports could be necessary catalyst for an upside break in GBP/USD.

AUD: Risk of Downside Surprise in Chinese IP

The Australian, New Zealand and Canadian dollars ended the day unchanged against the greenback.  The big story last night was the Chinese trade numbers and tonight, more data out of China means more potential volatility for the AUD and NZD.  According to the latest reports, China's trade surplus increased in the month of November thanks to the 12.7% rise in exports. This report should have lifted the commodity currencies but unfortunately slower import growth raised concerns about domestic demand.  In fact, the drop in imports suggests that tonight's industrial production and retail sales report could also be poor, leading to further losses in the AUD and NZD.  The Australian economy in general has been lacking and this can be seen in the further decline in job advertisements. In contrast, New Zealand manufacturing activity rebounded in third quarter and house prices increased in November.  The Reserve Bank of New Zealand meets on Wednesday and while improving economic data should keep the RBNZ hawkish, the persistent decline in AUD/NZD makes the central bank uncomfortable.  Yet their pain threshold is higher now that China overtook Australia to become New Zealand's number one trading partner in April.  Increasing sales of meat, diary and pine logs have made China a major consumer of New Zealand's exports. The outlook for NZD depends on whether the central bank's places greater emphasis on their desire to raise rates next year or their concern about the high level of the NZD. Meanwhile Canadian housing starts grew less than expected in November but the impact on the CAD was nominal. 

EUR: Shrugs Off Weaker German Data, Hits 1 Month Highs

The resilience of the euro has been nothing short of impressive.  Despite a smaller German trade deficit and a 1.2% decline in industrial production, the currency pair climbed to a fresh 1 month high against the U.S. dollar.  Our colleague Boris Schlossberg provided some useful insight. He said, "There are several possible reasons for euro's surprising strength. The strong labor data out of US and the robust Trade Balance numbers from China suggest that global growth may be better than consensus view. Under that scenario, both US and China could act locomotives for global GDP expansion and help lift Eurozone out of its funk. We have noted for several weeks that the EUR/USD has been benefiting from very positive capital flows as investors chase relative valuation and the better economic data continues to provide ballast for that trade. One other possible reason for euro resilience is the fact that despite positive labor sector growth the Fed may be in no hurry to taper given the tepid rate of inflation in US. Several analysts have pointed out that along with Friday's consensus beating NFP, investors also saw the release of Fed favorite inflation measure the PCE index which printed at 1.1% - well below the 2% target rate favored by US monetary officials." So while the euro should be trading lower based on data, external factors is keeping the currency supported and technically the uptrend is strong and as long as the currency pair holds above 1.3675, a move above 1.38 appears likely. 

Nikkei Rally Drives Yen Crosses to New Highs

The Japanese Yen extended its losses against all of the major currencies today with this persistent weakness driving EUR/JPY and GBP/JPY to fresh 4-year highs. European currencies have been performing far better against the yen than commodity currencies but all Yen pairs have been trading well thanks to the more than 2% rally in the Nikkei overnight and the rise in USD/JPY.  While 10 year U.S. bond yields were unchanged today, the enthusiasm from Friday's non-farm payrolls report continues to support USD/JPY.  Last night's Japanese economic reports were mixed with GDP growth revised lower for the third quarter, the current account surplus turning into a deficit and the Eco Watchers Survey rising.  While the downward revision in GDP was expected, the first current account deficit in 9 months caught investors by surprise. Apparently increases in exports and investment income were offset by a huge jump in fuel imports. Since the devastating earthquake in 2011, Japan's needs for fuel imports have distorted the trade and current account balances.  However the impact on the Nikkei was limited because the deterioration in trade in the month of October and the downward revision to Q3 GDP are expected to be temporary.  As shown by the increase in the Eco Watchers survey, which measures sentiment, the outlook for the fourth quarter and the first 3 months of 2014 is bright.  This explains why speculators are holding such large amounts of short Yen, long dollar positions. According to last week's CFTC IMM report, long USD/JPY positions are at its largest level since June 2007 and this means that the risk of profit taking is high.