In FX The Day Belongs to Draghi

Market Drivers for October 2 2014

Dollar selloff in Asia reversed partially in Europe
BoE asks for more macroprudential powers
All eyes on ECB
Nikkei -2.61% Europe -0.80%
Oil $89/bbl
Gold $1215/oz.

Europe and Asia:
AUD Building Approvals 3.0% vs. 1.1%
AUD Trade Balance -.79B vs. -.75B
GBP UK PMI Construction 64.2 vs.61.7

North America:
EUR ECB Presser 8:30
USD Weekly Jobless
USD ISM Services 10:00

Tho dollar took a whipping in Asian session trade today losing ground against all its major trading partners and after a small attempt to rally in early Europe it continued to weaken especially against the yen where it was almost 200 points lower since hitting fresh seven year highs yesterday.

There was no particular news to drive dollar weakness and much of the price action appeared to be profit taking that we have been warning about for days. The greenback has been severely overbought and yesterday’s combination of slightly weaker than expected ISM manufacturing numbers along with US yields dipping below the 2.50% provided the perfect excuse for taking some profits.

The comm dollars fared best after being sold the hardest over the past several weeks with kiwi rising more than 130 points off the lows while Aussie ran up to the 8800 level as the night wore on. With US yields retreating the high yielders in FX have once again attracted bargain hunters eager to earn carry. Indeed the dollar rally is unlikely to take true hold of the market until US rate begin to inch up. For now the fixed income market is clearly skeptical of the Fed policy moves and until it becomes a believer in the tightening cycle the greenback may have many false starts.

The one G-7 currency that did not participate the in the anti-dollar rally was the pound. The pair initially spiked to a high of 1.6250 then fell back below 1.6200 and then rallied back above the figure on stronger than expected UK PMI construction figures which came in at 64.2 vs. 63.7. However, the pair soon made fresh lows after the minutes of the BoE FPC meeting revealed that the central bank was seeking more macroprudential authority from the Treasury including the right to cap mortgage loan to value and loan to income ratios.
Such requests suggest that the BoE may be seeking alternative ways to curb housing market demand rather than through the standard interest rate measures. The BoE is increasingly reluctant to raise rates given the slowdown in the overall UK economy and the lack of any inflationary pressures, but at the same time it wants to control the demand in the housing market that has ballooned as a result of its low interest rate policy. UK monetary authorities may be taking a page out of the RBNZ playbook on macro prudential tools and the market clearly does not like the prospect of delays in moving off the ZIRP policy. Cable drifted to test the support at 1.6160 lows by mid-morning London dealing.

In North America today the focus turns to Mario Draghi and the ECB as traders try to ascertain if the ECB will initiate any new policy proposals to expand its accommodative stance. Almost no one expects any further rate cuts as Mr. Draghi has repeatedly stated that the central bank has reached the near limits of the lower bound rate policy. However, the focus will rest on the size and scope of the ABS program including the idea that the ECB may begin buying lower qualiuty debt products from Greece and Cyprus.

Ultimately however the market is unlikely to react much to Mr. Draghi’s rhetoric unless the ECB chief puts forth fresh proposals that will markedly expand the ECB balance sheet. With EUR/USD having fallen more than 1200 points off yearly highs, much of the bad news has been discounted in the currency and with US rates going lower there would be little pressure to sell the unit further unless Mr. Draghi makes additional policy moves.