FX Traders React to Surprises from Central Banks

The U.S. dollar traded lower against all of the major currencies after the FOMC minutes revealed the Fed's logic for keeping interest rates unchanged in September. They were worried about the downside risks to inflation, dollar appreciation and the challenge that a premature rate rise would have on their credibility. As a result, they felt that it was "prudent" to wait for more clarity on the outlook before taking action. While many FOMC officials expect liftoff to begin this year, a number of policymakers wanted to let the jobless rate fall below the full employment level before raising rates. Unfortunately they can add the labor market to their concerns this month. With non-farm payrolls growth slowing significantly and wages stagnating, the tone of this month's FOMC minutes will be less hawkish. More importantly though we now know that not only did the Fed want to see a further improvement in the labor market but they also need to see a turnaround in inflation. We anticipated a more hawkish tone and based on the price action of the dollar, the rest of the market did as well.

This morning's ECB minutes posed no threat to EUR/USD but given the central bank's dovish tone we were surprised by the single currency's strength because European policymakers expressed concerns about the economy and inflation. According to ECB chief economist Peter Praet long-term pessimism is restraining growth and the "challenges facing emerging market economies were clouding the global outlook and were unlikely to recede quickly." There was also "broad agreement that downside inflation risks increased" and in turn they indicated that there's still a substantial degree of stimulus in the pipeline and QE will be frontloaded to prepare for lower liquidity in December. While the central bank also indicated that it is premature to conclude that these developments will have lasting impact on the euro area, there's no doubt that they have grew more cautious on their outlook in early September. Unfortunately things have only deteriorated in October with Germany reporting back-to-back disappointments in economic data. Just this morning, Germany, the locomotive for European growth reported a significant deterioration in trade activity. Exports dropped by the largest amount since 2009, causing the trade surplus to shrink to its smallest level in a year. However not only was external demand weak but internal demand contracted as well with imports falling by the largest amount since November 2011. Outside of U.S. dollar weakness, the only explanation for the EUR/USD's resilience was the lack of urgency to increase stimulus. The notion of boosting the program was not taken seriously at the last meeting and shortly after the release of the minutes, German Bundesbank President Weidmann rejected calls for easier monetary policy by saying that easing wouldn't strengthen growth substantially. Investors look at this to mean that if the head of Germany's central bank isn't worried then perhaps they shouldn't be as well.

The British pound on the other hand underperformed after the Bank of England suggested that inflation could remain below 1% until the spring of 2016, which is longer than anticipated. They also expressed concerns about the global economy and the negative impact of fiscal consolidation on domestic activity. The BoE said, "a deterioration in the global demand environment would slow the pace of expansion further." Wages have been on the rise but the outlook is not positive enough to take inflation (CPI) back to their 2% target. Yet the BoE has far less to be worried about than the ECB because thanks to real income growth, productivity, robust business and consumer confidence, consumer spending is resilient. As such we believe that EUR/GBP should be trading lower and not higher.

The Japanese Yen traded lower against most of the major currencies following another round of weak data. Machine orders plunged 5.7% in the month of August and the trade deficit grew to -Y326B from -Y108B. While the outlook component of the Eco Watchers survey, a sentiment index increased, the current component declined more than expected. The Bank of Japan left monetary policy unchanged this week but if this trend of weakness continues, the central bank may have step up their efforts. Chinese markets reopened after their long holidays and the Yen pairs could take their cue from the performance of the Shanghai Composite.

Early gains in USD/CAD were erased by the strong rise in oil prices. The price of crude rose more than 3% today towards $50 a barrel. Canadian data was also better than expected with housing starts rising 230K and new house prices increasing 0.3%. 1.30 is a very important support level for USD/CAD and a break would require strong close below 1.2970.

The Australian and New Zealand dollars extended their gains on the back of firmer commodity prices and a rise in Chinese stocks. No major economic reports were released from either country and nothing substantial is expected this evening. However 8 days have now past without a down day for AUD/USD and NZD/USD. This is the longest stretch of strength for either currency since June 2014. With resistance about 50 pips away for both pairs we could see a bit more strength before a reversal.